Lord of the Lands Between, All Hail The Emperor!

M&A Monday: Chapter 1: What Kind of Buyer Am I? Now that I have started a newsletter, I am going to be more organized with my M&A Mondays. This may be basic for some people, but I want to start at the beginning of the acquisition process and work through to the end. If you are a buyer it is important to define yourself. How you define yourself will impact your support group, investors you attract, the conferences you attend, and deals you focus on. Using the right terminology shows others that you speak the language and acts to immediately focus the conversation. It is also an important way to introduce yourself to sellers and sellers’ brokers. Note that buyers grow through these stages. I have a client who started as an SFS 5 years ago, then moved to be an independent sponsor, and is now raising his first PE fund. Below is an explainer on the different types of business buyers and important differentiators. (A) Self-Funded Searcher; (B) Search Fund; (C) Independent Sponsor; (D) Private Equity Fund; and (E) Strategic Buyer. (A) Self-Funded Searcher (SFS). SFS is a buyer planning to acquire and run a business. A self-funded searcher is different from a search fund in that they do not take investment prior to closing the acquisition. Target EBITDA: The SFS usually acquires a business making less than $2M EBITDA (between $500k and $7m enterprise value). Financing: SFS usually finances their acquisition with personally guaranteed SBA 7(a) debt. The 7(a) loan program will fund an acquisition up to $5M (or more if the bank provides a matching amount (pari passu)). The SFS will usually have to put a downpayment of around 10% (I will do a post on the 7(a) loan in a future chapter). The rest of the equity usually comes from investors or is funded by the SFS’ own savings or IRA. The type of investors at this stage are usually friends, family, investors, or (in recent years) small institutions. The investors receive preferred equity. Ownership: The majority of post-closing ownership is owned by SFS. If SFS brings investors, the ownership will be less than all, but is still usually majority (see POST on structuring a deal with investors: teapawt.net/Eli_Albrecht/status/16…. Management: SFS usually acquires a business that they plan to run as the CEO, at least for a period of time. (B) Search Fund (SF). SF is like SFS, but they raise equity from investors (Search Capital). This is usually designed to bankroll the search process and then those same investors have a right to invest in the acquisition target (Acquisition Capital). Target EBITDA: The SF usually acquires a business making more than $2M EBTIDA – often much more. Financing: Since these targets tend to be larger and the ownership structure does not work for a 7(a) loan (investors above 20% have to personally guarantee), more traditional debt is used. This means a larger downpayment, which is raised from the initial investors. Ownership: SF ownership traditionally gives common equity to the SF. This traditionally is between 20%-30% and vests in 3 tranches: upon acquisition, over certain periods, upon achievement of certain IRR/MOIC thresholds. As more SF investors enter the market and more SF opt for self-funded search, I am seeing SF get better terms than traditional terms. Management: While a SFS controls the search process and management of the business, a SF has less control. They are the CEO after closing, but the investors usually have rights (in certain circumstances) to replace the CEO. One SF investor told me, “don’t worry, we almost never replace the CEO.” This did not make me less worried. (C) Independent Sponsor (IS). IS, also called fund-less sponsor is very much like a SFS. Their hallmark is flexibility and collaboration. They often partner with other sponsors and have hyper-flexible structures. Target EBITDA: $2M + I have seen IS take down targets between $2M EBITDA and $10M EBITDA. Financing: The IS debt and equity financing partners are almost always institutional investors and lenders. The debt is non-recourse (not personally guaranteed). Ownership: Ownership varies widely based on the structure and financing. Sometimes, a private equity-style waterfall is used where the IS sponsor gets no equity, only promote and carry. Other times, IS sponsors keep a majority of the equity. Some equity is usually set aside for a management pool. The IS is usually in control of the search and the target after closing, subject to rights of the investors. Management: IS almost always has a professional management team in the business. Sometimes this is the existing management other times they are put in place by the IS. The IS receives a management fee. (D) Private Equity Fund (PE). A PE fund is similar to an IS, but they are backed by a fund. PE uses institutional debt take out by the acquisition target (Leveraged Buy-Out) to fund the acquisition. They equity portion comes from the fund. They tend to be fee-heavy and have more traditional models. (E) Strategic Buyer. Strategic Buyers are buyers that already have a business and are acquiring another target to complement their business. Finding the right label is a personal decision that weighs the costs and benefits of each approach.