Becoming a minority shareholder while contributing ALL of the down-payment?
David Barnett
I help you buy or sell a business anywhere with appraisal, consulting , coaching and training services.
What’s fair from an investor’s point of view?
A post about being a minority shareholder in a small business…
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I had an interesting call the other day with a fellow in California.
He has the opportunity to invest $250,000 for a 20% ownership stake in a business acquisition.
Cool.
He wanted my opinion on how to check out and examine this opportunity.
So, I started asking some questions…
Naturally, you’d think that if he was investing $250,000 for a 20% stake in a business, this business would have a price of $1,250,000.
Like, that would be 20%, right?
Nope… it was a $5,000,000 business acquisition!
Furthermore, the buyer was going to put 95% debt onto the business, ie they were borrowing another $4,750,000 to buy it.
So, in reality, this investor was being asked to put up 100% of the down-payment in exchange for 20% of the equity.
I first ran into this concept during a presentation being done by a search fund investor.
I had asked him the question you’re likely asking right now… does it make sense to put up 100% of the equity at the time of purchase in exchange for owning only 20% of the equity long term?
His response… (and this guy was in the US) If you hold 20% or less of a business, you don’t have to personally guarantee the SBA loan.
So, the buyer’s personal guarantee is worth 80% of the equity?
Good question, let me circle back to this later.
What will happen to this investor if everything goes well?
Well, over time, they’ll get 20% of any dividends issued from the profits of the business, and, as the debt is paid down, their 20% will eventually be worth more than the $250,000 that they put in.
In fact, once the debt is completely gone, if the business value remains the same, their 20% of this $5,000,000 business would be worth $1,000,000.
So, that seems pretty awesome, right?
Well, if things go bad, the buyer (80% owner) will likely have to declare bankruptcy and the investor will only be out the $250,000 as they didn’t sign any guarantees.
So, it offers a bit of insulation to comfort the investor.
Would you do this if you had $250,000?
What if it was your ONLY $250,000?
You see, I think it doesn’t make sense if you only have $250,000, but if you have $2,500,000, then it might make sense to do this deal 10 times over.
My gut tells me that this methodology is a bit of a hybrid between equity investing and venture capital diversification strategies.
So, did the guy move forward with the deal?
No. He didn’t.
But it’s not because the business looked overpriced or anything.
It was because the business buyer was a total stranger who had approached them via a cold message on LinkedIn.
So often when I hear of stories of people making equity investments in business acquisition deals, I hear the following…
We didn’t invest in the deal, we invested in the person.
If you’re trying to find private investors to help you raise the down payment for a business purchase, they need to know that you’re the real deal.
That you’re trustworthy.
That you have industry experience.
That you have some analogous business experience, at least.
That you’re going to fight to make things work no matter what.
It’s a tough ask to a stranger.
Think about your personal networks.
Raising investment in your deals starts WAY before you find the deal.
AND, is generally way more difficult to do than simply having cash of your own and qualifying for a bank loan.
Cheers
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David C Barnett
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