Allocating equity in self-funded search

October 12, 2023

by a searcher from KEDGE Business School in London, UK

I'm new to the ETA world and was planning to launch a search fund, but am drawn more and more to a self funded search.
I'm just trying to understand how outside equity gets allocated when I'm also putting money down myself.

I'd appreciate your input on the following (simplified) example:
Price $1.25M

250k deferred payment
500k loan
250k personal/buyer contribution
250k third party investors

In this scenario, does the ownership become 50/50 between me and the investors, as we've both put 250k?
Or do the investors own 20% as they've invested 250k in a 1.25M company?

It seems surprising that they would instantly own 625k (50%) of the company value for a 250k investment.

How is this usually treated?
Many thanks in advance!

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Reply by a professional
from Lancaster University in London, UK

Hi Florian, as ^redacted‌ mentioned you should allow for your time and effort as well. Let's say you incorporate a new company now and take 100% of the equity for a nominal amount. This company has very little value now but if you manage to get terms with a lender and HOTs for a transaction (as well as build up management and deal experience) then arguably this company has some value. For ease let's say the value is £100k, this means that when the investor and you put more money in, the £250k only buys each of you circa 40% of the equity. The exact value attributable to your time and effort will be a matter for negotiation with your investors. I'd also point out that it is usual for management to receive some form of equity incentive and for searcher equity (or some of it) to potentially have different rights to investor equity which might entitle you to an enhanced return if you manage a profitable exit in the future. I hope that helps, feel free to DM me if you would like to chat it through.

Reply by an investor
from Western Washington University in Key West, FL 33040, USA

I would structure it as $500k of participating preferred stock (your $250k plus their $250k) with a preferred return and a liquidation preference. Then I would say that this $500k is convertible into 500 shares of common equity upon repayment of the liquidation preference and preferred return. I would also allocate yourself some additional common equity units. Perhaps 750 units (60% of the common). Thus, after the return of the preferred capital, you would own 1000 common units (80%) and they would own###-###-#### %). The only nuance is that if they own 20%, they will have to PG the loan if you're getting an SBA loan? So you might only want to give them 200 of the 1250 total units. https://twitter.com/Slackwatercap/status/1673782355478163458

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