Last week I posted about the generational opportunity to buy small businesses owned by the Baby Boomer generation. 2.3 million businesses are owned by Baby Boomers and over 60% have no succession plan. These businesses will change hands over the next 15 years.

Many of my clients are small private equity funds, independent sponsors, and individuals focusing on buying these businesses and professionalizing them.

Today's M&A Monday is about how to structure a deal with investors in a self-funded searcher-style deal.

Self-funded searchers are individuals buying a business using SBA 7(a) loans for less than $2m EBITDA/$10m sale price. This structure will look very different for independent sponsors, search funds, and private equity (I’ll discuss those models in a later post).

A client called me after my last M&A Monday and said, I would love to buy a business, but do not have the savings to put down 10%-20% for the business.

Most acquisitions are structured with a combination debt and equity. In the self-funded market, the debt is usually provided by an SBA 7(a) loan (up to $5m), which usually covers 80% +/-. The rest is cash the buyer brings, but that portion can also be provided by investors.

Investors are usually offered a portion of preferred equity and a step-up on their basis. Preferred equity is paid back first (both the initial capital plus a percent return). The step-up increases the investor's percent ownership to account for the business being worth more post-closing.

Let’s take an oversimplified $5m acquisition example. With fees and working capital (if not included in the purchase), we have a total enterprise value of $5.5m. The SBA loan will lend 70% ($3.85m) and a Seller Note will be 10% ($5.5m). The investors will put in 20% of the enterprise value ($1.1m).

Now assume investors are being offered 9% preferred return (accruing each year) with a 1.5x step-up (this is negotiable and sometimes searchers do higher preferred and lower step-up, etc.).

The investors will own 30% of the post-closing business and the Searcher will own 70%.

Finally, in a sale scenario. Let’s say you grow EBITDA by 6% per year. In year 5 EBITDA is $2.408m. Now that EBITDA is over $2m the multiple may be higher, let’s say 5x. The sale price will be $12,044,030. After paying off debt of approximately $2m and paying back investor's initial investment + preferred return of $1.595m, there is $8.449m available for distribution.

This gets distributed per ownership percentage (or "pari passu"). 30% goes to investors ($2,534,709 for a total return of, $4,129,709) and 70% to the Searcher ($5,914,321). See Excel breakdown in my Twitter post:

Of course, these are rough estimates for demonstration and each variable will vary.

This is a very high-level explanation of how we structure a Searcher acquisition with investors in the sub-$2m EBITDA market.