Giving equity and Cash Flow

March 24, 2021

by a searcher from Georgia Institute of Technology in Huntsville, AL, USA

Greetings all -

I've got what is probably an extremely basic question that I've avoided asking because it seems like one of those things that "everybody knows" - and yet it's never spelled out directly anywhere. As such, I'm just going to bite the bullet and admit my own ignorance by asking:

When you make a purchase and give equity as part of that purchase (either to the seller, to an investment group, to an advisory board, etc)... Will those equity holders receive payouts on some ongoing basis (as part of your net profits), or does that group not receive a return on that equity until you sell the company?

Thanks,
Jon

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Reply by a searcher
from Massachusetts Institute of Technology in Los Angeles, CA, USA

the short answer: it is up to what you and your investors agreed on. This should tie with the investment thesis, funding structure etc, governance and operating structure, your financial projections and constraints on the debt-service (assuming there is debt in the acquisition). Are you buying the business because it's a nice cash-flow business (and excess cash can be distributed) or because you want to grow the company (and will require re-investment of cash back in the business to invest in sales, product, operations etc.)? This is a fundamental question you will need to answer for yourself. Once you know the answer, align people who agree with you.

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

I'll echo the other responses and add another component to consider. Look into preffered returns on investopedia etc. Some investors will want to be paid out prior to the search funder is paid any profits putting them second in the capital stack behind any senior note debt. This is called a preferred return and the percentage of payout above and beyond the initial investment is negotiable and usually has a time component. After the preferred return is fulfilled the profits will flow through what ever pro rata structure for common equity that is in place in the operating agreement of the LLC as Mike Adhikari pointed out.

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