Cashflow distribution for investors/partners

May 04, 2023

by an investor from Columbia University - Columbia Business School in Seattle, WA, USA

I don't have much experience in capital structures/fund raising so wanted to get educated on this topic as I think through how to fund a deal.

I'm a solo searcher and plan to use SBA loan to the extent I can, mixed with seller note if available. Depending on the deal size, there's a good chance that I'll have to bring in an investor/partner for the down payment/equity.

Let's hypothetically say I pay $3M for a business with $1M EBITDA. To keep it simple, let's say I finance 90% with SBA and no seller note. For the 300K down payment, I bring $150K of my own cash and have an investor fill in the rest $150K.

Now my question: does the investor own 50% of the company (And thus entitled to 50% of the free cashflow) or does he/she actually own only 5% (150K/3M).

So assuming no tax, does the $1M in EBITDA get distributed in the following way?
- Assume debt service is $400K/yr, so that gets paid to the lender
- I agree with the investor that I would take $150K in salary,
- Now the remaining $450K - if we decide that we didn't wanna reinvest in the business and just distribute all remaining cash, do my investor and I split this 50/50? In other words, we each get $225K? Or does the investor only get 5% of 450K?

Could anyone help explain how distribution usually works with equity investors? If there are any good resources to read up on deal structures involving investors, that would be very helpful as well. Thanks!

Reply by a professional
from Dartmouth College in Los Angeles, CA, USA

You would typically be entitled to a larger % attributable to sweat equity, in addition to your salary (though not a management fee because of the salary). But, the investor would typically have priority in repayment and a preferred return, which would be paid prior to any distribution to you. Ranges of sweat equity vary widely.

Reply by a searcher
from Harvard University in Boston, MA, USA

It's a negotiation; talk to multiple investors and bring them a proposal where you've modelled out their returns (assume a pref of ~10%) and then see how much equity they would need to hit a 30% IRR under your base case scenario (i.e. business experiences no / historical growth only)

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