When are profits distributed to investors? Can I buy them out any time?

February 27, 2020

by an investor from New York University in St. Louis Metropolitan Area, USA

I am new to search funds and am in the U.S. I have a simple question: if I find investors who want a, say, 20% annual return, would they expect to get their 20% paid out yearly or would it accrue and be paid out when I sell the company?

If I did distribute the agreed-upon return yearly, could I have a clause that would give me the right to buy back at any time their shares for the price they paid? So, for example, Bob invests $200,000. Year 1, he gets his 20% return = $40,000. Year 2, same thing. At the start of Year 3, could I buy him out for $200,000 provided there was a clause to gave me that right? The reason I ask is that I may want to keep the business for the long term whereas investors want an exit strategy. Or I may decide that I am tired of paying the 20% every year.

Reply by a searcher
from University of Pennsylvania in Dubai - United Arab Emirates

The construct you described is essentially a high interest loan. There are some investors who will be fine with that, However more typically one thinks of the target return as an "all in" return which would include the cash portion paid during the life of the investment and exit distributions. If you have an interest in potentially keeping the business long-term you have several options on how to do that ranging from ROFRs to explicit call options. No sophisticated investor will accept that this be at a capped return (e.g. 20%) because while they may be targeting an all in 20% they will not want to forgo a potential 25-30% if that were possible. I have seen GPs buy out their LPs to create an evergreen capital structure using an open process to set the valuation to avoid conflict of interest. The GP team did not need to pay the same price as the other bidders because they were willing to live without reps & warranties and other complications hence they paid less. They financed the transaction through their own funds (rolled their carry and contributed personal cash) as well debt.

Reply by a searcher
from Fordham University in Norwalk, CT, USA

Yes, it is possible. Recently saw a deal w/ call and put provisions that allowed GP to buyout LP & LP to demand to be bought out by GP at a fixed time and periodically thereafter at a valuation established by an independent party agreed to by both the LP & GP. As others have said, you can structure it however you would like, but terms that are not favorable to LP's may make it more difficult to raise equity.

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