A traditional search fund's investors fund the acquisition equity, so the searcher can buy with conventional senior or unitranche debt from a bank or private credit fund, a seller note and investor equity, reaching a larger company in exchange for a minority stake earned over time and an investor board. A self-funded searcher keeps most of the equity but usually buys a smaller company with a government-guaranteed loan and a full personal guarantee. Lenders underwrite the target's earnings either way; what changes is who stands behind the loan.
- Who pays for the search
- Search fund: investors. Self-funded: the searcher
- Usual senior debt
- Search fund: bank or private credit, senior or unitranche. Self-funded: a government-guaranteed loan
- Equity at closing
- Search fund: the investors. Self-funded: the searcher's cash and seller paper
- Personal guarantee
- Search fund: usually none. Self-funded: full
- Searcher's ownership
- Search fund: a minority, earned over time. Self-funded: usually a majority
- Size of company
- Search fund: set by the investors' appetite and the debt market. Self-funded: capped by the loan program
Two ways to pay for a search
In a traditional search fund, the searcher raises a modest pool of search capital from a group of investors to cover a salary and the costs of looking. When the searcher finds a company, those investors have the first right to fund the acquisition equity, and their search capital typically converts into the deal on stepped-up terms. The searcher earns an equity stake in tranches: part at closing, part over time, part on performance. The investors own the majority and sit on the board.
In a self-funded search, the searcher pays the costs of looking out of pocket, finds a company, and finances the purchase largely with debt, putting in personal savings and often bringing in a few individual investors only for the equity gap. The searcher keeps most or all of the ownership and all of the personal risk.
The lender cares about the difference because it changes who stands behind the loan. For a funded searcher, it is an investor group with money beyond the deal and a board that can act in a bad year. For a self-funded searcher, it is the searcher, personally. Lenders underwrite the target's documented cash flow first in both cases; see search fund capital structure for how they weigh a buyer who has never run the company.
The two routes side by side
| Traditional search fund | Self-funded search | |
|---|---|---|
| Search costs | Paid by search investors | Paid by the searcher |
| Acquisition equity | Search investors, sometimes with co-investors | Searcher's cash, seller paper, sometimes a few individuals |
| Senior debt | Conventional senior or unitranche loan from a bank or private credit fund | Usually a government-guaranteed loan, capped in size |
| Junior capital | Seller note on agreed terms; mezzanine or an SBIC on larger deals | Seller note, usually deeply subordinated |
| Personal guarantee | Usually none; the lender relies on the equity beneath it | Full, from the searcher |
| Covenants | Coverage and leverage covenants, tested quarterly, often with equity cure rights | Usually lighter; the lender leans on the guarantee |
| Seller rollover and earnouts | Common, subordinated to the lender | Restricted under guaranteed lending |
| Searcher's upside | Minority stake earned in tranches | Majority or all of the equity |
Where the self-funded route stops
Most self-funded searchers borrow under SBA's 7(a) program, whose loans go up to $5 million, with a full personal guarantee from the searcher. That makes it possible to buy with little cash, and it also sets the ceiling: a company with $10M to $100M+ in revenue has usually outgrown what that route can finance. A conventional senior lender will not fill the gap on its own either, because at 2x to 3.5x EBITDA, the range senior cash-flow lenders to lower-middle-market companies commonly lend, a searcher with little equity is left short of the price.
Past that ceiling a self-funded searcher has two choices: look for a smaller company, or raise equity for the deal once a target is under letter of intent. The second turns the searcher into something close to an independent sponsor, and lenders underwrite the deal that way: the equity raised, who provided it, the searcher's economics, and the quality of the target's earnings. See independent sponsor vs private equity fund.
Self-funding keeps the equity and caps the company. Investor backing trades equity for access to the debt market that finances companies this size.
Financing a funded search acquisition
Because the search investors fund the equity, a funded searcher buys on conventional terms. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA, and unitranche lenders stretch further; a seller note, subordinated to the senior lender, fills part of the rest, and investor equity the balance. Take a target earning EBITDA of 1,500, priced at 7,500, with closing costs and working capital bringing the total to 7,800.
| Sources | Amount | Uses | Amount |
|---|---|---|---|
| Senior term loan, 2.5 times EBITDA | 3,750 | Purchase price | 7,500 |
| Seller note, subordinated | 750 | Closing costs and fees | 150 |
| Search investors' equity, including converted search capital | 3,300 | Cash to the balance sheet for working capital | 150 |
| Total | 7,800 | Total | 7,800 |
The senior lender then tests coverage on the payments. Conventional bank lenders commonly look for debt service coverage of at least 1.25x, and a private credit lender will set leverage and fixed charge coverage covenants against its own model of the business. Where the senior loan will not stretch far enough, a unitranche loan can replace the senior loan and part of the seller note, at a higher blended rate. See sources and uses.
What the funded route gives up is ownership and a measure of control. The investors own the majority, sit on the board and approve major decisions, and the searcher's stake depends on the company performing. The conventional loan brings maintenance covenants, so a bad year can put the company in technical default even when payments are current; an equity cure funded by the investors is often the answer, and lenders value investors who can provide one.
What lenders look for in a first-time chief executive
A searcher has usually never run the company being bought, and often not one in the same industry. Lenders that finance search acquisitions regularly know this and underwrite around it:
- The target's earnings, first. A quality of earnings review of the latest full year, never an older one, and a year-to-date P&L. A first-time chief executive does not rescue a file whose earnings cannot be verified, and does not sink one whose earnings can.
- The transition. A seller who stays for an agreed period as a consultant or board member, a second layer of management that is staying, and a plan for the customer and supplier relationships the seller holds personally.
- The investor group. Who the investors are, whether they have backed search acquisitions before, and whether they can fund a cure or an add-on. A strong group partly substitutes for the searcher's missing track record.
- Rollover and seller paper. A seller who rolls equity or carries a note is still invested in the outcome, which lenders read as confidence in the earnings. See rollover equity in acquisition financing.
How the searcher is paid also matters. Lenders will read the searcher's salary, bonus and equity vesting, since they come out of the same cash flow the loan is serviced from.
What the lender will ask for, and how the file is built
For either route, the lender wants the target's latest full year of figures for every company being bought, never an older year, and the letter of intent. For a conventional term loan, that means the P&L, a year-to-date P&L through last month-end, the balance sheet and a debt schedule, often with an AP aging; for a funded search, add the investors' commitments and a model showing coverage and leverage after the new debt.
Midas Partners's lender book holds 1,800+ lenders, 1,148 of them writing term and private credit, banks, unitranche funds and SBICs among them. Once the documents are in, Midas Partners builds the full lender package, with the financing model, lender presentation, blind teaser and underwriting memo, in a day; by hand, the same package takes at least a week. Lenders that fit see the blind teaser first, and the searcher and investors approve each lender by name before it learns who the target is, which matters when the seller has asked for confidentiality. See the package.
Common questions
- Can a self-funded searcher buy a company with $10M to $100M+ in revenue?
- Usually only by bringing in equity investors once a target is found. At that point conventional lenders underwrite the deal much as they would an independent sponsor's: the equity raised, who provided it, the searcher's economics and the target's verified earnings.
- Do search fund investors sign personal guarantees?
- No. Institutional and individual search investors generally do not, and lenders to funded search acquisitions rarely ask the searcher for one. They rely on the investors' equity beneath the loan, the covenants and a lien on the company's assets.
- Which lenders finance search fund acquisitions?
- Banks, private credit funds and unitranche lenders, with SBICs and mezzanine funds for junior capital. Some lenders finance search acquisitions regularly and understand the model; others will want more equity or a longer seller transition to get comfortable with a first-time chief executive.
- Can the seller stay on to help?
- On a conventional deal, yes, on whatever terms the buyer and seller agree. Lenders generally like a seller who stays for a transition as a consultant or board member, and many welcome a seller who rolls part of the proceeds into equity.
- Does a lender treat a first-time searcher differently from an experienced operator?
- Lenders weigh industry and management experience. A searcher without it strengthens the file with a transition plan, a retained management team, a strong investor group and a seller who stays to consult. None of that rescues a file whose earnings cannot be verified.