Should search capital be included in the uses of funds?
May 30, 2023
by a searcher from HEC Montréal in Montréal, QC, Canada
Hi,
I am modeling a transaction and am having trouble determining whether or not the search capital should be included in the uses of funds. I understand that in the case where none of the initial SF investors follow, you have to repay the search capital + the step up.
But what happens in a transaction where all or most of the initial investors roll their equity? You don't really need to repay this capital. Does this mean that SF capital should not be included in the uses of funds? But how do you take into account the equity rollover then?
Thanks for your help !
from University of Alberta in Calgary, AB, Canada
We have the full search equity repayment as a use and early on will assume zero as rollover to conservatively estimate the acquisition equity required (assuming all search capital is bought out). In the PRN process, you are actually indicating that you are raising up to $xxMM for the transaction (the maximum amount that could be raised).
Ideally you are getting this amount as close as possible to the actual amount being raised, but you also need a fairly good view on your cap table which may not occur until after the PRNs come back and could be further muddied with seller equity rollover (we also try to understand whether most investors are participating or not prior to the PRN so have a fairly good view). This maximum PRN amount also does not include the LP units exchanged for LLC units. Once you have a better view of participating or not, you can keep updating the S&Us as appropriate in the model.
Ultimately, uses should always include the full amount of your search capital for a CAD deal as you will either be buying them out (funded with excess cash from your search capital or by raising additional new acquisition equity beyond the standalone equity requirements of the transaction itself) or doing a contribution & exchange (whereby participating investors exchange their LLC units for LP units).
You may have multiple tranches of uses as equity, including new acquistion equity (true new cash being raised as part of the PRN process), remaining cash from search capital (if any), stepped up search capital being rolled over, equity rollover from the sellers, etc. The total equity box (i.e. the preferred equity in the transaction) should be the same regardless of the allocation between these buckets.
Note: everything describes above relates to modelling for the transaction and is different than the actual "funds flow" on closing from a legal which is a different beast. Hope this helps and happy to chat further.
from The University of Chicago in Chicago, IL, USA
Incoming search capital should be included in sources and use of funds. Regarding equity rollover, are you referring to seller equity rollover?