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ETA Deal Flow
Most deals posted by entrepreneurs fall into the "ETA" or "Entrepreneurship through Acquisition" category. Acquisition targets are sourced by motivated entrepreneurs who have an acquisition opportunity under LOI. These are mostly profitable small businesses with $100k - $3.0M of EBITDA. Deals typically fall into one of the following categories:
Entrepreneurs and Executives
Experienced professionals raising equity funding to acquire a company that they will run as CEO. These deals are often financed with an SBA 7(a) loan which requires a personal guarantee from the entrepreneur and a 10% minimum equity injection. Entrepreneurs use our platform to find investors to finance the equity injection.
Self-funded Search Funds
Self-funded searchers are most often early career professionals looking to become CEO by acquiring a small business. They often spend 1-2 years to source an attractive investment opportunity and then relocate to run the company. Self-funded searchers use our platform to identify investors and raise capital after signing an LOI.
Traditional Search Funds
Similar to self-funded searchers, traditional searchers are early career professionals looking to become CEO by acquiring a small business. Traditional searchers often look for larger and more scalable companies. Traditional searchers identify investors and raise search capital before starting their search. In addition, they may have equity gaps and need to raise additional equity after signing an LOI. Traditional searchers use our platform to raise search capital and fill equity gaps.
Most independent sponsors are M&A professionals with an attractive deal under LOI. These professionals partner with experienced management to run the target company. Independent Sponsors behave like private equity firms but raise capital on a deal-by-deal basis. While most independent sponsors won't take a full time job at the target company, they add value in an active and involved oversight capacity and may offer attractive investor economics. Independent Sponsors use our platform to identify equity investors for their deals.
Economics and Structure
Financial terms in ETA transactions vary widely and are often the result of negotiations between the entrepreneur and investors. Investors typically expect a return in the 20-35% IRR range with conservative model assumptions (low growth, entry multiple equals exit multiple, etc.).
Deals are most often structured using a participating preferred equity instrument with a preferred interest and a participation in common stock. While terms are highly deal specific, the following ranges are typical:
- Preferred interest: 8% - 10%
- Investor participation in common stock: 20% - 80%
The investor participation depends on deal attractiveness (multiple paid, historical growth, quality of business) but is also highly dependent on the amount of equity raised. For small equity raises, it is not uncommon to see investor participation in the 20-50% range while larger equity raises will often be done at 50-80%. The equity split between investor and principal also depends on the deal type and is typically higher in independent sponsor transactions and other situations where the principal does not take a full-time management role.
An entrepreneur is acquiring a $1.0M EBITDA business for $5.0M, takes out a $4.0M SBA loan, and raises $1.0M in equity from investors. The investor terms are 10% preferred return plus 50% participation in common. After 5 years the business is sold for $7.0M and has $2.0M in remaining debt.
In this example, the sales proceeds would be distributed as follows:
First, the $2.0M bank debt is repaid
Second, Investors receive a return of their $1.0M capital contribution.
Third, investors received a 10% preferred interest on their capital contribution. After 5 years, the accrued amount would be $0.6M.
Forth, investors receive their participation from the amount allocated to common stock. In our example, $3.6M is allocated to common stock (= $7.0M sales proceeds, minus $2.0M remaining SBA debt, minus $1.0M investor capital contribution, minus $0.6M in preferred interest). Of the $3.6M allocated to common, investors would receive a 50% participation, so $1.8M.
The total return to investors in this example is $3.4M (=$1M return of capital + $0.6M in preferred interest + $1.8M common participation) and the Investor return 3.4x MOIC and 27.7%.
Role of Investor
The role of the ETA investor could be passive or involved. Scenarios we have seen in the past include the following:
Investors are passive, but receive quarterly business updates from the entrepreneur and have voting rights on key decision (most common scenario).
An investors who contributes a large percentage of the equity capital joins the company's board and contributes in an oversight capacity.
An investors who has specific domain expertise related to the business joins in an advisory or board role.
An investor contributes a large amount of the equity capital and becomes an operationally involved partner in the deal.