Step-ups in self-funded ETA

A couple days ago I published this post with the initial title “Step-ups don’t belong in self-funded ETA.” I really appreciate the thoughtful perspectives and the time people took to weigh in. After reading through the comments and reflecting on the dialogue, here’s what I’ve gathered: 1) The “step-up” terminology may not actually be the best label. It’s effectively a rule of thumb applied to the equity contribution to balance risk, return, illiquidity, and governance exposure. 2) As John and others pointed out, it’s really more of a step-down for investors when you consider that ownership is often calculated off enterprise value rather than equity value. This makes the convention somewhat misleading in name but directionally reasonable in outcome. I appreciate the framing. 3) There’s plenty of nuance here, and reasonable parties can disagree. 4) I completely agree that investors deserve robust returns in ETA. If we modeled a typical case; say, a $1mm EBITDA business bought at 4.5x with 85% leverage (senior + seller note) and 15% equity; investors would probably need around 30% of the common for the deal to pencil. So in reality, we may all land in roughly the same place economically. Maybe I just got hung up on the “step-up” language. In hindsight, I could have framed the original post more thoughtfully. Some of the early wording invited more friction than clarity. But I’m genuinely grateful for the exchange. ***Original*** Title: Step-ups don't belong in self-funded ETA I recently attended a webinar where Tim Ericson discussed applying a “step-up to common” structure in self-funded search deals that take on outside equity. Essentially giving investors a 1.5x–2.5x equity multiplier on their cash contribution. To be fair, this concept makes sense in a traditional funded search, where investors finance the search phase and bear pre-acquisition risk. In those situations, a step-up is a reasonable way to reward capital that’s at risk before a deal ever exists. But in a self-funded search, particularly one that raises outside equity to pursue a larger acquisition, that logic breaks down. In these deals: - The searcher carries 100% of the pre-deal risk — sourcing, diligence, opportunity cost, and sunk expenses. - The searcher provides the personal guarantee on the SBA debt, often covering 70–90% of the total capital stack. - Investors join at close, once the deal has been structured and de-risked. At that point, the investor’s capital risk deserves fair returns — but not a “step-up” designed for a completely different model. It’s not about how much capital is being brought to the table; it’s about who is bearing what risk. We should be modeling and negotiating around IRR and MOIC, not arbitrary ownership percentages. If a deal doesn’t pencil for investors with a pref and a reasonable share of common equity, the issue is the deal’s economics, not the cap table. If we want the ETA ecosystem to stay healthy and sustainable, we need to keep these distinctions clear. Otherwise, we’re just recreating the same investor-skewed dynamics that self-funded search was meant to escape.