Non-SBA loan options for search fund?

September 11, 2024

by a searcher from Duke University - The Fuqua School of Business in Seattle, WA, USA

Hi everyone,

I'm nearing the final stages of identifying a target company for my search fund. I've found a promising opportunity that aligns with my investment thesis and am now focused on securing the necessary funding for the acquisition.

While I've explored SBA-backed loans as a potential option, I'm also keen to explore other financing avenues that might be more suitable for my specific needs. My target acquisition is in the entertainment/tourism space. I need roughly $3M to make the purchase. I plan to invest $500K, but can go up to 33% equity injection.

What have you considered as an ideal debt/equity balance while structuring your deal? I am also considering seller financing in the mix, primarily to have the seller continue to be invested in the success of the business.

I'm open to any other suggestions or recommendations you may have.

Thanks!

Reply by a searcher
from INSEAD in San Francisco, CA, USA

Regarding the debt/equity mix, it's important to strike a balance between maximizing your return on capital and managing the operational risks associated with high debt levels. I recommend thinking of yourself both as an investor (and separately) as the operator.

As an investor, your capital should aim for a return that reflects the level of risk you're taking—many search fund investors target an IRR of around 30%. As the operator, you also need to ensure that the return on your sweat equity makes sense and that you're not over-leveraging the business, which could strain operations.

To find the right debt/equity balance, try modeling the deal to achieve an IRR close to 30%, and adjust from there based on what feels right given the business's cash flow.

In terms of alternative financing options beyond SBA loans, you might consider a HELOC or CRELOC if you have real estate assets, traditional financing from a bank, or even a pledged asset line if you have other liquid assets that can serve as collateral. Seller financing is a great idea as well—it helps align the seller's incentives with the ongoing success of the business.

Reply by a searcher
from University of Southern California in Charlotte, NC, USA

Sounds like you are well funded for an initial investment for a significant down payment.... I would never do a deal without Seller Financing. I'd push for as much as you can secure from the seller. I've had it were once I explained the compounding interest and tax advantages of the seller loan I've had sellers want to hold a bigger loan. Seller loan also gives you an avenue to recoup issues that arise post close. With a combination of seller financing and your owner carry, you will be able to find a lending source for the rest. I've seen success going to the sellers back if they have a long term relationship especially if it is a small local one.

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