Seeking advice on structure and terms for equity investors

April 18, 2024

by a searcher from University of Pennsylvania - The Wharton School in Bellevue, WA, USA

Background: I am a self-funded searcher who plans to also self-fund the majority of the equity as well. Using hypothetical and simple numbers, let's assume a $4m purchase price to be funded 75% in SBA 7a debt and 25% in equity (so $1m in equity). The $1m in equity to be comprised of $700k from me (70%), $150k from friend A (15%), and $150k from friend B (15%).

Question: What would be reasonable or typical equity structure and terms for these two investors in this type of deal? I prefer to keep things simple and leaning towards common stock, but I also recognize that I am taking on outsized risk due to the personal guarantee that only I will have, since the two individual investors are each below the 20% threshold. Would common stock or preferred stock be recommended in this case, and if so what would be a reasonable structure and and terms? Thank you!

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

You're structuring the deal with all parties receiving common equity based on their capital contributions—70% for you, and 15% each for the two investors. Since you're personally guaranteeing the SBA loan and will be operating the business full-time, you’ve also built in a promote: after everyone’s initial investment is returned, you receive 80% of the profits until a certain return threshold is hit (for example, a 20% IRR), after which distributions revert back to the original 70/15/15 split. This keeps the structure simple—no preferred equity or complex terms—while fairly recognizing the outsized risk and operational responsibility you're taking on.

Reply by an investor
from Ivey Business School at Western University in Boca Raton, FL, USA

Typical deal terms would be 80% SBA, 10% seller note, and 10% equity; if your deal is###-###-#### 5x EBITDA with moderate capex, it should pencil out to enable more debt and less equity. Typical investor terms would be preferred equity at 2x step-up (i.e. their 25% funding of the deal sources would equate to 50% economic ownership), a preferred return OF their capital, and a 10-12% preferred return ON their capital. If you're looking for investors, or yours are open to this idea, I offer a unique 'zero-rate' preferred equity structure whereby I waive the preferred return ON capital in exchange for the sponsor prioritizing the post-closing use of cash flow for the repayment OF my capital, before other uses such as expansionary capex or acquisitions. Maybe your investors would be open to that idea, or feel free to DM me or email me at redacted if you're looking for investors.

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