When do investors pay the search phase funds? Once off or in tranches?
February 11, 2021
by a searcher from University of Cambridge in Johannesburg, South Africa
Looking for some practical advice here - a 2 part question
1.) Do investors pay in the Search phase budget to the fund in one go? Or in tranches (e.g. every 6 months)
2.) What happens to unspent search phase funds? Are these rolled into the acquisition at the 1.5X step up? rolled in without a step up? Or paid back?
In the scenario where you raise for a 24 month search and find a company within, say, 3 months, the way you handle the unspent funds will impact equity dilution. Would be keen to understand what's worked for others.
from INSEAD in Hermanus, 7200, South Africa
May seem onerous on the Searcher, but here's why: it's a relatively small cheque per investor if going the traditional route with###-###-#### investors, so most investors want to 1) just get the admin done and pay the USD50K or so in one go. Paying that in 8x tranches at ~USD6k a piece x 15 or so investors, is a lot of admin hassle that you and your bankers need to go through. 2) investors are putting money to work, they ideally don't want to have "committed" capital earmarked that's earning <1% that they can't use for anything else, given that they need to have that cash ready when you call for it. It makes portfolio planning and deployment dynamics difficult if doing this over 30+ searchers across a portfolio from the investor's perspective. Lastly - you don't want to be dealing with drawdown admin or any concerns that an investor may have trouble contributing say 6 months in, and then being worried about your own burn being covered, and changing the dilution mechanics etc while still in the Search phase. You'll be busy enough dealing with Owners, Deals and interns - just not worth your time or energy.
Hope that helps to not just give an answer, but also why it's more practical from a funder's perspective (and probably a Searcher's perspective too). As Paul mentioned, the real game is more post deal, where quick exits and cash backs can help drive IRRs (sometimes) on much higher numbers relative to the smaller Search-stage cheque.
from Harvard University in Dallas, TX, USA