Self Funded Search Investors - Standard Waterfall?

April 29, 2025

by a searcher from University of Michigan - Ann Arbor in Greenwood Village, CO, USA

I've been pursuing a self funded search and am now working on a deal for a business with about $1.5M EBITDA. I have 2 investors who will be getting relatively standard ETA investment terms - 2x step up, 10% Pref, etc. I have one question about how the waterfall works in such scenario. I understand the first 2 tranches in the waterfall are the preferred return for the investors and return of their capital. Once their capital is returned, is the next tranche generally return of capital for the searcher or is return of capital for the searcher not generally included in the waterfall (in which case, once investor capital is returned the next step would be pro rata distributions)?

Reply by a searcher
from Columbia University in Fairfax, VA, USA

The most fair and common waterfall structure I've seen for Self-funded Search is: 1) PREFERRED DIVIDENDS: Investors earn a Preferred Dividend based on the agreed Preferred Equity Rate (%) and the outstanding balance of the amount invested. Meaning, as you return capital over time, the dividend amount proportionately decreases. 2) RETURN OF CAPITAL: Investors are repaid their original capital plus any accrued Preferred Dividends before profit sharing begins. Once fully repaid, these payments typically stop and and Profit Distributions begin. 3) PROFIT DISTRIBUTIONS: After all capital and dividends are returned, remaining profits are split based on the equity ownership in the company. In my opinion, it's best to treat everyone (including the Searcher) who invests money in the deal the same. So, that would mean the Searcher would hold both Preferred Equity and Common Equity. On the Searcher's Preferred Equity portion, they would get the same benefits as any other investor (e.g., Preferred Dividend, Return of Capital, liquidation preference, etc).

Reply by a searcher
from University of California, Berkeley in Los Angeles, CA, USA

Does anyone have an excel, or other example, illustrating this?

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