11 Comments

Would challenge the assumption that the comp for a CEO in a 700K EBITDA and 3M EBITDA business would be the same. IMO a more proper comparison would double the CEO compensation in the funded example to 250 in line with the 2020 Stanford primer update.

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Makes sense, you're right on that, thank you for the comment! Thought not sure it will change the "directionality" of the answers that much -- key point was that the big money outcome for traditional searchers is always in the exit because they have such a large pref to overcome.

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Yep totally agree on that point. It was more towards the de-risking of a no-growth scenario. In the funded situation you are drawing a "market rate" salary -- which is helpful to know if you were to do cost-benefit against say a traditional post-MBA path.

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This is really great! Any chance you'd provide the excel spreadsheet? It would be really helpful.

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Thank you! Honestly I think I've lost this spreadsheet into the sands of time sadly, otherwise would've been happy to share.

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I find this article and corresponding model really helpful. I don't fully understand, though. How did you arrive at the investor proceeds of $691,235 in the self-funded / no growth scenario? What are the components that went into that to calculate that number?

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That's just the math of the model. The basic components are cash flow in excess of debt payments, the 8% accrued return, the exit proceeds, etc. Like the investors get their capital back, an 8% annualized return, and then 25% of the remaining proceeds, and the math worked out to the $691K figure.

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I'm confused by the equity splits in your table for the searcher. It says investor puts up 80% of the capital but only receives 25% of the equity?

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That's correct. But they also receive preferred equity with a fixed rate of return. So first they get their money back + the X% return (8-12% generally), then they continue to own 25% of the common equity.

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Interesting how it differs so much to traditional PE. What drives the difference so much?

Do you find that people rather want a guaranteed rate of return in search, but are still happy to take equity risk?

It seems they would get a lot less out vs being an LP for a higher risk equity investment (single SMB vs a fund)?

I haven't had a lot of conversations with smb investors so no idea what they expect, would be keen to see the structure/examples of people that have done this?

Lots of questions and enjoying the learnings!

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The reality is that these deals are priced so cheap (<5x EBITDA) that even with that small common equity check, the deals pencil out to 35%+ net IRRs with limited or no growth.

Of course the risk levels are high relative to regular PE, but I think SMB investors view this like angel investing but with a much tighter range of outcomes given the businesses are already cash flowing & proven at time of investment. The default case is "make money" whereas angel investing the default case is "company fails to find product-market fit".

Compared to a regular PE fund, I think the math is still quite attractive for LPs given a PE fund will target mid-20s IRRs and delivers a net teens return. This is just a higher risk-profile version of that, but if they do 10 deals that do reasonably okay, they should easily be at a net 20s IRR even if 1-2 deals blow up.

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