Deal Structuring 101
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Happy Wednesday folks!
Thanks for joining us for another edition of Atlasview Insights. We’re back with another week of sharing bite-sized insights that are relevant to small business owners, dealmakers, and investors.
If you are not familiar with Atlasview Equity, we are a private equity firm specializing in software and tech-enabled businesses. You can learn more about our team and investment criteria: here.
In this newsletter, we cover:
Deal Structuring 101
Atlasview’s Investment Criteria Breakdown
Our Favorite Reads
Insights From Our Team
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We look for the following characteristics in our partner companies:
Industry: Software and tech-enabled businesses
Business Profile: Sticky B2B customer base
Size: Minimum $1m EBITDA or $5m ARR
Geography: The US & Canada
Whether you’re a business owner interested in working with us, or an intermediary with a deal to share, always feel free to reach out and get in touch with us!
Deal Structuring 101
This week we wanted to share some notes from a talk that Jay Vasantharajah, our Managing Partner, recently did in Toronto. The talk was on some of the basics of deal structuring (bear in mind, these are jot notes).
A quick intro on deal structuring:
Structuring is great, it can align incentives for buyers/sellers.
As a buyer, it allows you to manage risk better, reduce upfront cash outlay required.
Sellers can generally get a higher valuation (and therefore more money for their biz) compared to just cash upfront.
That said, it generally does make an offer less attractive - if a deal is competitive, less structure.
Complexity can also be a deal killer.
Let's dive into the 3 most common forms of deal structuring.
Earnout
What is it
Consideration paid contingent on hitting specified objectives.
Objectives could be numerically based like future revenue, EBITDA, gross profits or they could be qualitative based like a client contracting renewing.
Pros
Shifts some risk of future business performance from buyer to seller.
Less cash upfront for the buyer.
Seller can end up making more cash with an earnout.
Cons
Earnouts are unattractive to sellers because they don’t have control of new business (so less control of hitting targets).
Can lead to disputes between seller/buyer on whether earnouts were achieved.
Tips
Generally used to bridge a valuation gap, if you think biz is worth $10m on trailing numbers, and seller thinks its worth $15m on forward numbers, a $5m earnout might make sense.
The more objective the targets, the better. Objectivity starts to shrink as you go from revenue down to EBITDA/profits.
If the earnout is achieved, rather than paying it immediately all at once, convert earnout amount into a seller note and then pay it down over time (so the business doesn't get sucked of all its cash).
Seller note
What is it
The seller becomes a lender and effectively lends you money to buy their business.
Usually its interest bearing, principal amortized over time, or in some cases, paid in a bullet at a future date.
Pros
Seller knows exactly what they will earn post-sale (compared to earnout), no ambiguity - interest-bearing seller note might be a great addition to their fixed income portfolio (think retirees).
Allows buyer to obtain more leverage, juicing equity returns.
Generally, it’s cheaper cost of capital compared to many other forms of debt from external lenders.
Cons
As with any form of leverage/debt, more if it increases risk and reduces the flexibility of the business.
Might cross hairs with lenders, might cause some complexity if you had to borrow more money at a future date.
Tips
Ensure seller note is subordinate to any other lender (otherwise you will have a hard time getting loans).
Include flexibility clauses, long grace periods for missed payments, steps for remedy if default, discuss with seller upfront.
Don’t offer personal guarantees for this note (usually sellers won't ask for it).
Seller equity rollover
What is it
Seller takes some equity in your new entity instead of cash.
Not particularly common in SMB acquisitions (searchers, etc.) but very common in LMM private equity.
Pros
Aligns seller and buyer (both own the same go-forward biz, so vested in its success).
Seller gets a second bite of the apple, another large payday (if your plan is to sell the biz in a reasonable timeframe).
Cons
Your seller is now your business partner (may be a good or bad thing), accounting for the highly leveraged nature of SMB buyouts, even small amount of equity roll might mean meaningful equity stake - say you leverage 4:1 and rollover 10% of purchase price, seller will own 50% of the biz.
Particularly unattractive to sellers, especially if they’re older, low-risk tolerance, illiquid equity in an SMB is not valuable to them in retirement and may not want to wait for the next payday.
Tips
Ensure rolled-over equity is common equity without voting rights, and outside equity raised is prefeed equity with voting rights. Preferred equity gets (at least) 1x liquidation preference, so they get their money back first in the event of a sale.
Communicate to seller what you plan to do with biz so they know what to expect as an equity holder (sell in 5 years? Hold for dividends?).
Use in cases where seller can add significant value post-close (complex transitions, expertise in expansion and or other value-add initiatives where seller can be crucial for execution).
Conclusion
Always remember to consult with your deal lawyer/CPA to ensure everything is done correctly
Hope this helps, structuring is just another tool to your deal toolkit
Our Favorite Reads
Insights from our Team
Operations
Investing
Atlasview’s Investment Criteria
We look for the following characteristics in our partner companies:
Industry: Software and tech-enabled businesses
Business Profile: Sticky B2B customer base
Size: Minimum $1m EBITDA or $5m ARR
Geography: The US & Canada preferred
Whether you’re a business owner interested in working with us, or an intermediary with a deal to share, always feel free to reach out and get in touch with us!
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About Us
Atlasview Equity is a private equity firm specializing in software and tech-enabled businesses. We combine patient capital with proven operational strategies to deliver predictable results for our stakeholders.