How do I value equity in a self-funded deal?

February 13, 2023

by a searcher from Indiana University - East in Atlanta, GA, USA

If I'm looking to bring on a few minority investors on a deal, what's a typical equity investment valuation? For example, if I'm buying a $2M company, financing through SBA for 80%, seller financing 10%, and looking for $100K outside equity investment to go alongside my own $100K equity, would you typically value the $100K outside investment as a % of the purchase price, meaning 5% in this case? What kinds of factors would cause adjustments in that equity valuation?

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Reply by an investor
from Harvard University in Denver, CO, USA

Hi James. Typically in a self-funded deal this sort of outside equity will come in as preferred equity. That means they get the right to get their $100k investment back, plus a "preferred return (often 5-8%), and then once the investment is paid back, they convert into a negotiated percentage of the common equity. Typically, your $100k cash invested would be treated on the same terms. So, the first $200k of cash flows to equity, plus accrued preferred return, would be split 50/50 in your example. After that original capital has been repaid, the split changes so that you as the manager get some "free" common equity in exchange for your time, and to incentivize you to perform. If the preferred equity converts into 70% of the equity (I've seen everything from 20% to 80% depending on the attractiveness of the deal), in your example, the splits on all further cash flows after the preferred is paid back would be 35% outside investors, 35% your own preferred equity investment, and 30% common to you personally in exchange for your management time and effort.

Here, the investors are putting up 50% of the equity (can't think of it as 5% of total purchase price, that's mixing equity and enterprise value concepts), and will expect something like the above, not 5% ownership.

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

Lots of great comments already. From the lending perspective if you are using an SBA 7A loan, you need to structure it as equity. It cannot be a loan and count as your equity. If it is preferred equity, there cannot be any mandatory requirements to make distributions or repayment during the term of the SBA loan.

As for what percentage of the company you give them, I have seen it worked as you suggested where they get a percentage based on the overall capital stack. I have also seen it where they get a higher percentage. So long as they stay under 20%, they are not required to sign a personal guarantee on the SBA loan. The SBA does not require the amount of equity they can you to match up with the percentage of the business you give them. So someone can give you 50% of the required equity and you could give them a 1% ownership interest if you could negotiate that.

If you have additional questions from the lending perspective, I am more than happy to discuss. You can ping me here or directly at redacted Thank you.

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