How to structure follow on deals in a Search Fund?
March 20, 2022
by an member from Universidad Nacional de Educación a Distancia in 11100 San Fernando, Cádiz, España
I was wondering how do searchers usually structure follow on deals when i.e. building a platform company from which they add on new companies.
Do they open access to follow on deals to new investors? Do they just do a regular capital raise to fund the new acquisition? Is it structured as some kind of side pocket to the original deal? Are IRR/MOIC tables for searcher compensation (equity accrual) revised when a new deal is closed?
Any thoughts and ideas would be useful. If anyone here has closed follow-on deals on their SF, it would be very interesting to know how they personally structured it.
from Harvard University in Omaha, NE, USA
This is tough to answer succinctly because the various paths follow-on deals can take leaves a lot of room for creativity.
But here is my attempt at a succinct response:
1. It begins with the operating agreement with your investors/Board, search thesis, and search approach.Answers to many of your questions above start here and how these things are originally constructed and papered.Not that you can't renegotiate later, but good to have alignment on follow-on acquisitions from the get-go.
2. My goal has been to use a combination of cash from my business + the combined debt capacity of the companies to finance a deal.Seller consideration is on the table as well.My first follow-on had an earn-out component while my second acquisition was straight cash (with an escrow).Out the gate, I want to avoid having to raise additional capital from my investors.My first follow-on was a mix of cash and debt.
3. If the deal will need additional investor capital, look back to point 1 on how that goes.For my second deal, we moved banks and the new bank required a small equity investment as part of getting to know us and bringing us on.My investors and I investment here was pari passu, but that's how our agreement was structured.I likely could've negotiated something different on this deal given our performance and IRR/MOIC to investors at that point, but I could do the investment, it was a large deal, and I believed it was important to show my level of conviction to my investors.My second deal was mostly cash from the business and debt with a small equity injection.
4. The last point is if you need to bring in outside capital.This opens all sorts of discussions with your Board on the direction of thecompany, the current IRR/MOIC to investors, and the implications of bringing in outside capital, such as PE.I can't really speak to this point from experience, so someone else will have to chime in.
from Universidad Nacional de Educación a Distancia in 11100 San Fernando, Cádiz, España