Deal structure for a self funded searcher with one financial backer?
May 16, 2023
by a searcher from University of Auckland in Auckland, New Zealand
Hi all,
I am exploring buying a business with a financial backer and would greatly value any insights/thoughts/criticisms into the high-level deal structure below. Recognize this is quite different from the traditional search model but I have the financial partner lined up and the simplicity seems to make sense for me. Perhaps as a searcher/operator, I am taking on an unfair share of risk, but get a material shareholding up front and will also be looking at an 'enduringly profitable', low-risk business to acquire.
(Searcher / Operator)
- Finds business
- Acquires business
- Runs business
- Owns 50% of business
- Receives average market salary
- Receives distributions once acquisition capital/loan is paid back to financial partner
Financial partner - Provides acquisition capital (50% and 50% funded by bank) - Acquisition capital from financial partner provided as an interest-free loan - Has a Board seat - Owns 50% of business - Receives loan repayments and once loan is repaid, received distributions.
Questions/considerations
- Personal guarantees for bank debt (likely with operator?)
- What happens if further capital required (perhaps agree that financial partner will make available an additional % up to x?)
- Key shareholder agreement terms (key decisions, dispute resolution, right of first refusal, shotgun clause)
- Other considerations?
The other piece of context is that we wouldn't necessarily be looking to double value and sell within 5-8 years. The more likely pathway forward if the first acquisition is successful would be to buy another business every 3 years with a long-term hold view.
Many thanks to the community, so many great learnings and insights from being on this platform.
Cheers,
Baz
from University of Pennsylvania in Atlanta, GA, USA
There are a large variety of structures and ultimately comes down to what you can negotiate.
What I have seen as relatively ‘standard’ in an SBA loan deal is:
70% bank debt
20% seller note
10% equity
Units of equity are sold to investors as participating preferred equity with 8-12% preferred return and 1x liquidation preference.
Investors receive 2-3x step up in their share of common, so if all equity was sold as preferred to investors then searcher keeps 70-80% of the common.
Considerations this raises for you are:
1. What size range are you looking at, above applies to SBA deals max $5-8m transaction value but above $2m EBITDA you may be able to get conventional debt with no PG and different investor terms.
2. Why not plan for seller note in your cap table, it is expected by many banks and obviously less dilutive to your equity share.
Overall from an investor perspective I think offering no preferred return is below market and allowing investor to keep 50% of the common is above market.
It could make sense for you though if plan is to long-term hold because I would not want to pay 10%+ preferred return over decades as that is quite expensive capital by recent historical standards and the underlying expectation in these deals is for a liquidation event in 5-7 years.
edit: saw after posting that you are in NZ with no SBA. Hopefully still a helpful reference point for what’s going on in the US.
from Yale University in Atlanta, GA, USA
In these scenarios where the investor provides all equity capital, they usually receive a "participating preferred" equity stake. This structure includes a paid-in-kind (PIK) yield, which accumulates over time and is paid out at a later date (either through the business cash flows or an exit event). This allows the investor to mitigate some risk by having liquidity preference and a "guaranteed return". Additionally, the investor would receive a share in the common equity, as you've outlined, to give them further upside.
Since you are providing a personal guarantee and are investing your time, expertise, and efforts into the deal over the long-term you get the upside of 50% of the equity returns, after the preferred equity is paid back.
Agreements regarding future capital requirements and shareholder terms are essential and this can be a grey area - especially if you are contemplating follow-on acquisitions. That may require some negotiation and legal advice.
Feel free to reach out directly for a more in-depth discussion. Best, Nathan