Acquisition Units - How to fill in blanks on my PPM?
December 05, 2019
by a searcher from Carleton College in Leesburg, VA, USA
I'm working on my PPM. I'm starting with the PPM exhibit from the Stanford primer, but I don't know how to fill in the blank in the "Right of First Refusal" paragraph that comes up twice in the document.
It says "Investors will have the right to participate in financing the acquisition, but are not obligated to do so. Depending on the size and structure of the acquisition, investors are expected to have the opportunity to invest another $______ to $______ per unit at the time of acquisition. Investors will be given the opportunity to provide 100% of the required equity in order to prevent dilution from outside investors. "
Is that range of figures typically some multiple of the unit amount on which I decided for raising the fund? My fund units are about $40,000, so the additional investment, in the deal, would be in larger units? Or just more units? Help!
from The University of Chicago in Chicago, IL, USA
I'll assume that you are raising $400,000 for your search because that makes the numbers easy. That implies you are selling up to 10 units at $40,000 each. For the rest of the example, I'll use the numbers in the Stanford primer. In the primer, it says the expected acquisition will be $7.5M to $20.0M. If you have 10 units given up to search investors, note that the next sentence says that search investors will have a chance to finance up to 100% of the acquisition. That means you would spread the financing for the ultimate acquisition across those 10 units if the search investors cover 100% of the acquisition financing (in theory - not necessarily in practice). [Note: you might use a larger number of units in the acquisition, but the 10 units refers to the holder of 1 unit in the search.] In any event, that would imply an investment of another $750,000 per search unit held by your original search investors... up to $2,000,000 per unit at the top end of the acquisition cost range. That's the 'depending on the size' portion.
Structure, on the other hand, refers to whether it's all cash or whether there's rollover equity, seller note and/or bank debt (and/or earn-out) components. The more you use structural elements to defer or substitute for cash at closing, the less you will need to tap your search investors (or other investors for that matter) for financing at the acquisition. That essentially lowers the per search unit cost of acquisition units later on.
On the lower end of the expected deal size range, along with some of those other structural components, that could suppress the buy-in below $750,000 per search unit that I mentioned above. If you think you'll use structural elements to finance the deal beyond cash for around 40%, then the search investor buy-in price might be as low (or lower) than the remaining 60% (or, in the case of $7.5M acquisition, then $450,000 per unit).
Now, you might be thinking, with all these variable elements and speculation going into this analysis, why even state that range? Well, a PPM is a disclosure document that is intended to put investors on notice of the prospects of their investment in your search so they can make an informed investment decision under the securities laws. Presumably, including this range is useful in that context. If someone is buying one of your search units for $40,000, you're essentially telling them that they'll have the opportunity to buy into the acquisition units with a much larger subscription opportunity. You are also implicitly indicating that you'll need significantly more cash from investors (whoever they might be) at the acquisition. The bottom line is that you are signaling to someone that, while their buy-in now might be $40,000, their "pro rata" when it comes acquisition time, could be a lot more. Not an obligation, of course. For the actual, binding legalese, see Section 3 of the Investor Subscription Agreement, which is Exhibit 6 to the primer.
Like I said, I've seen PPMs pretty much directly cribbed from the Stanford primer and folks will just modify and/or pull this particular reference. With a little wordsmithing, you could keep it and tweak it to say "Investors will have an opportunity to invest in the acquisition on a pro rata basis at such time and the amount of such investment will depend on the size and structure of the acquisition."
Feel free to msg me with other questions. Good luck!
Brian
from Dartmouth College in United States
So if you were planning on selling 3 units for your search, take the total amount of equity you expect to need for the acquisition and divide by 3 (i.e. each unit would give the holder the opportunity to acquire one-third of the total equity). The reason there is a range is to account for different transaction sizes and capital structures (i.e. the amount of equity needed will depend on the transaction size and the amount of debt funding).