Self-Funded Search | Transaction Assumptions

September 20, 2022

by a searcher from Rice University - Jesse H. Jones Graduate School of Business in Houston, TX, USA

Hi Everyone,

Self-funded searcher with no buy-side M&A experience. I'm wondering if my (hypothetical) assumptions (preferred rate, seller note rate, investor % of common) are in line with reality? Target is SMB Defense mfg with $2.5M Adj EBITDA.

EV = $9.75M
Cash to BS = $500K
Txn Fees and expenses = $350K

Capital Stack
47% Senior, SBA 7(a) (P+ 2.25%); P = 5.5%
25% Seller Note (8%)
28% Investor Equity (12% preferred rate + 30% of common)

Thinking preferred rate may be on the higher end? Have been advised 10-12%

Thankful for any guidance.

Best,
Adam

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Replies

Reply by a searcher
from Princeton University in Annandale, Clinton Township, NJ, USA

I don't know what the working capital looks like for businesses in this industry, but don't overlook the importance of giving yourself adequate cash to the balance sheet post closing. My gut is that $500k cash to the balance sheet looks light, unless you have a credit line in place at closing (which is a great way to add liquidity). In my experience so far, adequate liquidity is the primary determinant in being able to pursue growth initiatives, and if you don't give yourself enough cushion up front, you will be constrained from day 1.

Reply by a searcher
from Rice University in Houston, TX, USA

Thanks all, for your responses. I've received a ton of really helpful feedback.

Here's what I've learned (so far):

- The preferred rate is dependent on the risk associated with the deal. Higher rates for riskier deals. But 12% is on the high end. Generally preferred is around 7.5-8%. If investors are asking for higher preferred rate, it might be indicative of a perception of risk.

- The common equity to investors is generally 75% of the equity investment on the deal. So (generally), and in this hypothetical case, investor % of common would be around 21% (or 75% of 28%).

- Normal range for seller financing is 10-15%, but depends on circumstances of the seller and business. Riskier businesses should have more seller financing. The rate could go as low at 4%, but 6% is about right.

- Cash to BS should be a higher, just in case there was something missed during diligence or unforeseen post-acquisition expenses. (IE broken machine, etc.).

I'm planning to go higher-than-market on the preferred and common because I'd like my (strategic) investors to play an active role in the operations (IE customer expansion and general guidance) of the acquired business.

To answer ^redacted‌ and ^redacted‌: Yes, 70% of common would go to a combination of principal (me), my board of advisors with equity (up to 7%, in total) as well as a management incentive (of around 5%). PD would not provide any capital and I would take on the CEO role.

Hope this is helpful and would welcome any feedback. I'll continue to share as I learn.

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