How do self-funded equity distributions work?
August 17, 2024
by a searcher from University of Florida in Virginia, USA
Hi all,
I’ve reviewed a-lot of content on equity distributions on this platform, watched live oak’s webinar, and looked at other resources but I’m still having trouble understanding exactly how equity distributions work.
I think a concrete example would help. Can someone please breakdown how distributions would typically work using these simple, illustrative parameters?
- Total equity investment: $500k, of which $100k is invested by searcher. All of this is treated as preferred equity with a 10% annual coupon
- Investors require 30% IRR over 5 years
- Searcher has 70% common equity
- Annual cash available for distribution after debt payment is $500k
in New York, NY, USA
Any "actual" distributions that have economic value to investors though should be in line with what you communicated to your cap table ahead of closing. Some structures prioritize rapid conversion of the pref, and therefore you will have large distributions in the early years (this also helps to increase IRR, although at the expense of investing in the company.) Some will prefer to reinvest all excess cash back into the company, making a play for a higher exit value and willing to forego interim distributions. Maybe you do a little of both. Do you intend to make the 10% coupon in cash or let it PIK? Do the docs even allow you to PIK? In order to make your life easier as an owner and steward of investors' capital, you should clearly communicate your intentions and investors' expectations prior to funding.
from Harvard University in Lynbrook, NY 11563, USA
Year 1: Pref gets 50k in 10% coupon, then 450k in return of capital. 50k capital remains invested.
Year 2. Pref gets 5k in 10% coupon, 50k goes to return of capital, 445k remaining gets split 70/30.
Year 3: 70/30 split going forward.
The 30% IRR number is a target number, an output, not an input. You seem to be framing the 30% IRR as an input. You would modify your inputs (e.g., step-up, pref coupon, pace of capital return, split between searcher/investors) to try to achieve the desired IRR in your model (and then in real life, which is the harder part 😀).
If you have more leverage/can hit target IRR with slower return of capital, you might give the pref most of the cash, but keep some for yourself as well. Or you might reinvest some and return the capital slower. Hope this helps.