Pass the Hat: How Investors Evaluate Self-Funded Search Equity Raises

I'll introduce the panelists in a second, but first this topic: the equity raise, pass the hat. In self-funded searching, the majority of folks need to raise equity for their deals. There's a lot of fear around it. These guys are going to demystify it for you and tell you how to get it done. After seeing maybe a hundred folks go through the search process and raise money, I promise you the money is out there, as long as there's a good deal and a good operator behind it, and you know how to sell yourself and the deal.

I'm Ben Bortner. I'm a former searcher operator. I bought a pool company in Key West and ran that for three years. Before that, I was a partner at a hedge fund for five and a half years. I've been investing professionally for 15 years and investing in SMBs for the past five or six years.

My name's Tony Cappaert. I was a SaaS founder eight years ago, started a software business and sold it in 2019. Then I started buying cabins in West Virginia and built a vacation rental investment fund and a sister property management business called Blue Maple. Building that small business kept me interested in investing in other small businesses, so I started a fund called Workbench Capital. We invest primarily in self-funded search deals. We've done 24 deals in the last three years.

I'm Kevin Bibelhausen. I was a self-funded searcher who acquired his first business in January 2023, so I'm only 18 months ahead of some of you. Pretty immediately after that, I joined with a couple of other guys to start a fund investing back into self-funded search. I'm a general partner at Fruition Capital, and we have made eight investments with check sizes between $600,000 and $800,000 into self-funded deals in the last year.

**Best and worst practices when engaging with investors**

Tony: What we're trying to figure out is whether this is someone we can trust and someone who's going to do what they say they're going to do. We're investing as a small private investor, a minority investor, in a deal that's maybe going to exit in five, six, or seven years. When people come to me and they come across as fairly competent, like they've already done the research and know what search is about, that helps. I don't want to be the guy educating the searcher on how to put a deal together. I'm shocked at the number of people who I have a good conversation with, and I don't hear from them again for months until they have a deal. It's hard for me as an investor to feel like I can back them when I've only talked to them for 20 minutes. The best thing you can do is touch base with a couple of bullets, a random email or text every few months, just letting me know what you're up to. That's an obvious point, but maybe 20% of searchers do it.

Ben: A good process is being organized. A good approach is having a one or two page teaser highlighting the business, your thesis, the sources and uses for the deal, how much equity you're raising, and the terms you're proposing. Then we can determine whether it's a good fit. If it is, we can sign an NDA. Hopefully you've got a data room with the QoE, a SIM highlighting the deal, and your thesis. What not to do: don't look up my phone number online and call me at nine o'clock on a Sunday night. That's a real story.

Kevin: I'm a little different because I was a self-funded searcher. I don't mind talking to people in the beginning of their search. I genuinely enjoy talking to people at all stages. The tactical solution to what Tony is talking about: start a newsletter. Even if nobody reads it, you're building an email list and sending out regular updates. That's a muscle you need to develop, especially if you're going to raise capital. You're going to need to communicate with your investors monthly or quarterly, so you might as well start now. Nobody in this room thinks they're just going to do one deal. Building your email list is one of the best assets you can give yourself. I didn't do that in my search because I thought I had equity earmarked. I didn't do any investor communication or seeding the ground. Then I had to go a hundred miles an hour at the very end because my capital fell out. Do yourself a favor and build that list.

Tony: To piggyback on that, the same minority of searchers that aren't engaged upfront are the same post-acquisition. The amount of updates we're getting is scant, and it seems like pulling teeth. The folks who raised two years ago with non-fixed rate SBA debt as it flexed up, those businesses were paying a lot more debt service and struggling. Many of them were going to their investor pool saying we need to raise more capital. If you're not talking to your investors, it's really difficult to raise that capital. Similarly, if things are going well and you want to do a bolt-on, building that muscle is super critical.

**Check sizes**

Kevin: Our check size is the largest. We raised our first fund in the last year and deployed into eight different deals. Our check size is between $600,000 and $800,000. That may grow as we raise our second fund. We want to be the anchor investor. We don't necessarily want to take out your entire raise, but we want to be the large majority.

Tony: We're a little smaller. Our typical check today is $300,000. If it's a million dollar EBITDA business, typically 80% levered, you're raising about $800,000 of outside equity. That's a natural limiter to the size of the check or how your cap table gets constructed. We're almost never the only investor in the deal. We're typically one of the biggest, but typically not the biggest.

Ben: I typically like to be one of the lead investors, take the lead on negotiating legal documents with the searcher. For us, that's an average check size of $350,000 to $500,000 today.

**Benefits and downsides of small checks vs one large investor**

Tony: All of us interested in self-funded search care about autonomy, being able to call the shots. That means you can raise capital, mostly debt in the deal, with a little bit of capital from outside investors. If you've got wealthy folks in your family or friends, you can bring a lot of money on the cap table that doesn't have a lot of experience running or operating a business. That can be fine; money's green. But the trouble is when things aren't fine, not having people on your cap table who have a vested interest in trying to help you and the business grow is shortsighted. What you don't want is the other extreme: an investor who's really difficult to work with, up in your business, constantly being the boss. You want somebody who's going to have your back, understand the business, understand the levers of growth, and ideally those people are also on your board. I see folks raising deals trying to construct a board with no teeth and not a lot of equity investors with experience. That can work, but it's very risky.

Ben: There's value to bringing on an experienced investor who's been there, run a small business, and exited. I was a former searcher. I've operated. I enjoy working with other searchers, advising them through the closing process, dealing with the BS that comes up, and strategizing on how to grow the business. Once you outgrow your SBA lender, we can look at SBIC funds and private credit. I had friends and family as investors because there weren't really professional investors investing in self-funded searches back when I was a searcher.

Kevin: Give me a little runway here, this is my soapbox. I'm in a fund that writes big checks. I started my search with an equity commitment letter from a capital provider that said I had $5 million of equity available to me. That made me think I could go out and buy anything I wanted. That turned out to be BS, because three days before my LOI was signed, I got a call from a partner saying we're just super busy, good luck, we're tearing up the contract. I had to decide whether I could grind through and raise small checks or kill the deal. I went for it. I had to raise $800,000. My minimum check size was $50,000, so my cap table is pretty large. I've got over 10 people on my cap table. That's a lot of people to manage, especially during tax season.

I see this with searchers bringing deals to us. Once you figure out the economics of a search deal, you think, I get to keep all this equity, let me get as much as I possibly can. They split hairs over giving up an additional 5% because investor terms from a fund might be a little higher than family and friends capital. If you're splitting hairs over 5%, you're majoring in the minors. The idea is to have people who know what they're doing and have a real network we can call in to be your sounding board. Even if it means you raise small checks, it's incredibly stressful. You're going through the SBA process for the first time, going through legal for the first time, negotiating with your seller. My lease was up when I was acquiring my business, so I had to renegotiate a lease and got stuck with a 30% rent increase. Just pay a little more in investor terms and get rid of it.

With a fund like ours, we're investing in deals between $1 and $2 million in EBITDA. We never want to be the only investor on a cap table, but we will take out the majority of the raise. So if you're raising $800,000, Fruition might write a $600,000 check and say, searcher, you need to raise $200,000. That's a lot more manageable than $800,000. I can also point you to individual investors that like to co-invest and open up my network. You can put them on your newsletter and start creating an investor base for yourself.

Ben: All three of us have investors that like to co-invest. We can help make introductions. Go talk to other searchers that have one of us as investors. The people who invest in these deals are on almost all the same cap tables. It's a small world.

Tony: I would never want to have one investor with all my eggs in one basket. You probably want a couple. I would definitely want people who know what they're doing involved. I also would never take super small checks where I felt like I'm going to hear about this at Thanksgiving. My handful of really close friends that trust me, I won't let them be LPs in my fund because I don't want to hear about it whenever we're hanging out.

**Friends and family money**

Tony: If you get the read that this money is money that can't be lost, I would never take it. My friends who have invested in my funds or my last company, I said as much: pretend this money never comes back. How do you feel about that? If you're still cool and we're still going to hang out, then sure, we can talk about it.

Kevin: I didn't have the opportunity to raise capital from friends and family because I don't have family money and I don't have wealthy friends. I also would never have asked, because I didn't want to deal with it at Thanksgiving and Christmas and feel like I would have soured a relationship.

Ben: There's nothing more motivating than raising money from your friends and family and not wanting to lose that money. When you make a lot of money for your friends and family, that's also really rewarding.

**Non-obvious deal breakers**

Ben: If the margins are super high, it probably means the seller is doing a lot of the work. For me, it's a lot of new construction or a lot of customer concentration.

Tony: The deal has three components: the searcher, the company, and the deal terms. On the searcher side, there are broadly two types: someone with real operating experience and someone who doesn't, who has primarily finance experience. I over index on someone with real operating experience or a surrogate for that. People have mentioned investing in veterans. I love that profile. They were deployed managing a blue collar force. I can see that person working with a similar blue collar workforce in a manufacturing company. If you don't have that background, you have to have a reason why it makes sense.

Also, what's your time horizon? As someone who manages a small fund, I need liquidity in five, six, or seven years. If you're looking for a forever hold, that can be great for you, but I'm not going to be a fit unless there's a mechanism to get liquidity. On searchers, I've had some where in every little thing, they're trying to get the maximum they can get. At some point, it becomes too much. Is it a partnership or are you just an ATM machine?

On deal terms, there are norms. Deals don't get done below an 8% preferred return. The norm now is more like 10% to 12%. My average was 11% last year. On the percent of common you're giving to investors, you hear about a step-up. If you're raising 20% of the deal from outside investors because it's a highly levered deal, we need to share in that leverage with you, meaning we're putting 20% of the proceeds in but we're going to own more than 20% of the business. If you're raising 20% from investors and investors get 20% of the company, that's no step-up. That's so out of market it tells me either you're very greedy or you don't understand. Market norm is probably more like 1.8 now. I'm not investing below 1.5, and I see stuff as high as 3x depending on the quality of the business.

Kevin: That comes out of when you do your model. The rule of thumb has been 30% IRR is what you target. Most of us are not expert modelers. If you try to thread the needle on 30% IRR and your step-up is only 1.2, maybe you should increase that to 2 and the investors can share in the increased economics. It'll be more attractive. A lot of searchers look at IRR and back into the terms by the target IRR. If you do it that way, you're treating it as pure capital. If you spread the wealth a little more, you're treating us as partners. That's a good return for the amount of risk we're taking in a highly leveraged deal.

**Searchers without operational experience**

Ben: I didn't have any operating experience when I bought my company. The humbleness, willingness to learn, a thought-out strategy of how you're going to manage the business and the people, how you're going to relate to them.

Tony: Most searchers I encounter are in that bucket. I'm asking myself two things: Can you operate this business and will you be successful? And will you want to operate it? Especially if you don't have experience in the industry, lead the conversation calling out the elephant in the room: this is why I'm interested in search. Ideally it's not a spreadsheet reason. There has to be something from your background, your childhood, whatever, so it's not just chasing returns and you'll want to get out. On why you can operate, people have all kinds of experiences in undergrad or different jobs. Demonstrating that you can be very operational and have done things that are technical, not in a white collar office environment, is the best signal.

Kevin: We're all dancing around project management. You don't have to be an executive. What kind of projects have you managed? What kind of teams have you led? It doesn't have to be at work. Tell me a story and tell me why you think it'll translate to the business you're going to buy. Fit is incredibly important. Look at the way I'm dressed: jacket, green jeans, fashion glasses. If I show up to an investor meeting and I'm like, I've got this hot roofing company, I can buy it at two and a half x and I'm going to run the crews at seven in the morning, I have no cred. I was talking to Chris Williams who runs SystemSix. He likes to play golf on the weekends. Buy a business that fits you, not what the books say. I bought a textile company. It's a white collar design-focused business with a distribution arm. That fits me a lot better than going to buy an HVAC business because that's the hot thing.

Tony: Paired searchers are really attractive from an investor perspective. You have two different personas and backgrounds. One could be more operational, one could be more go-to-market or finance. I've done several deals like that and I love it. It's a small minority of the search community in self-funded that does paired search. If you're considering early stages and there's somebody you're close to who is also thinking about buying something, it would be really compelling and probably better for everyone.

**North star metrics**

Tony: IRR is the lead dog. 35% at five years is what I'm looking for. The trouble is there are a lot of ways to manipulate the forward-looking model. The base case assumptions about future growth, margins, and exit multiple, I want to assume in the base case all of that is the same as what the business has done historically. If you're going to buy at 4x and assume in the base case you'll sell for 6x, that's not conservative. The cash distributions are another. A lot of people get to 35% IRR by assuming they'll distribute a lot of free cash flow early. That may happen, but the vast majority don't return a lot of cash in years one and two; you're reinvesting and building a cash buffer. Returning cash early in the model is an easy way to inflate the IRR.

Kevin: I've heard him give that talk before. At the SMB bootcamp in March, you were doing that. Returning cash early juices IRR. I modeled that way and had a 50-something percent IRR, thinking I'm awesome, this is a slam dunk. No, I was just stupid. When somebody calls your baby ugly, your model, you have to listen. We look at IRR as well. We model in the thirties. As far as criteria, we're B2B only. We don't do home services. We want 10-plus years in business. We don't do anything in technology. Somebody brought us a Salesforce consultancy. Nice business, not for us, too much platform risk.

Ben: I don't care what your model looks like. I'll have my own. I'm looking for a quality business that's not too economically sensitive, paying a reasonable price, financing conservatively, fair investor economics, and a good plan. With a conservative case of steady growth and slight multiple expansion as we professionalize the business, that's a strong outcome. If we can do strategic things, it's a home run.

Tony: The reason I think of IRR is the businesses are different. If one business has historically grown 20% top line and EBITDA for 10 years and another has been growing 5%, the investor terms should not be the same. The former is a better business, so the investor terms can be worse, and I'm still confident I'll have a great outcome. If it's only growing 5%, I have to own more of the business and have a higher preferred return because the business isn't as attractive in future growth.

Ben: If we can do add-on acquisitions or other strategic things to grow value, the organic growth doesn't have to determine how the business actually grows once you own it.

**Negotiating term sheets and legal docs**

Ben: I have a term sheet I like to use. There are pretty standard ones floating around. SMB has theirs. Mine is pretty much a copy with a few things tweaked. Your salary should be capped and reasonable. You shouldn't be making all your money on salary. You're here to grow the business and get a huge equity check when you cash out. Typical minority rights: anything like taking on more debt or issuing more equity gets approved by a majority of the minority outside investors.

Tony: It's very standard where the lead investors will take the docs from your attorney to our attorney to mark them up. Each of our respective attorneys is doing what's best for their client. We're going to come to something fair. I encounter searchers occasionally where the deal is in contract, the cap table is filled, and no investors have requested to look at the docs, and there's surprise on the searcher's part that we'd want to red line them. That's a very normal thing. It's also normal to ask for those minor attorney costs to be paid for in the transaction. Don't wait until the last week to circulate an operating agreement.

Kevin: Negotiating term sheets depends on whether you're going to do the small check thing or get an anchor investor. The anchor investor will have a lot more say over the term sheet, and you'll take their red line seriously because they have more cash in the deal. If you do the small check thing, you have a lot more power. It's just more of a grind. It depends on what you're willing to give up. If you want it done so you can move on to the next thing, you're willing to give more preferential terms. If you feel you need to own 85% to 90% of the business and won't sleep at night otherwise, do the small check thing because you control more. Small check investors don't have a lot of power.

Tony: If we're negotiating over finite minute details, that's a bad signal. We can have fair terms for everyone and we're all going to crush it. If we're focused on little details, it's a red flag.

**Q&A**

When should a searcher reach out to investors? Tony: What you don't want is to get under contract and be scrambling. Put together a list of about 10 investors who write checks and are active. Reach out early in the search. Have an early conversation, then put us on the email list and drip us with updates. Don't spend a ton of time on it, but get a handful so you have peace of mind to move when you get under contract.

Are terms going up? Tony: Yes, both preferred returns and step-ups are going up. It feels counterintuitive because there's a lot of excitement in self-funded search. The terms are better. The quality deals I'm investing in have slightly better terms for investors. The searcher still gets the vast majority of the equity and it's still fair, but slightly better.

Minimum governance threshold: A real board with two representatives from the searcher, two from the investors, and one independent mutually agreed upon. A bolded list of what the board can do: issuing new debt, the salary of the searcher, selling the business. Where there isn't a real board with real investors, that gives me pause.

Kevin: We're all writing larger checks, so we'll require some serious governance. It's not traditional search, we can't fire you, but we want it treated like a real company with proper governance. We have a fiduciary responsibility to our investors.

Tangible value investors add: Tony: Immediate connections to other investors to fill the cap table. Placing someone experienced from the industry on the board, either from our LPs or our network. A sounding board for operational and people-related issues. All of us have run businesses, hired and fired people.

Ben: I've worked with portfolio companies on acquisition strategy, making introductions to lenders to refinance debt and take on more debt, and to potential buyers, whether strategics or private equity.

Kevin: We've got partnerships with growth marketing firms and vetted service providers. What about when you're actually in the chair? We've made a conscious effort to develop relationships with people who can help scale the business. A lot of them have been contractors I've churned through. Marketing, coaching communities, finance and accounting, pricing analysts. Friends and family may have those too, but we don't see you at Thanksgiving. It's purely business.

Do friends and family get the same terms as the fund? Tony: Generally everybody has the same terms. What you don't want is something done behind closed doors where someone feels they got a worse deal. If you're explicit in the deal docs that if you trip a minimum threshold of investment you get a different preferred return, that's standard in other assets.

Kevin: I did something similar. My minimum was $50,000. If you invested $100,000 or more, which was 3% or more ownership, I gave you a board seat. You have more capital at risk, so you should have the opportunity to sit on the board or name somebody on your behalf. I was explicit about that in my operating agreement.

Diligence on investors: Tony: Ask for referrals. Each of us has a website listing portfolio companies. Independently reach out to them. I would back channel every reference. Talk to someone I didn't introduce you to.

Kevin: Listen to your gut. I knew it wasn't a good fit with the firm that ended up dropping me, but I didn't feel like I had any other choice. You're functionally getting married to these people. Buy something with people you actually enjoy.

Tony: It reminds me of hiring. When I do a reference on hiring, I ask: Would you hire this person again? Would you allow them to invest again? Ask folks we've invested with: What's the best way to work with Tony? They might have unique insight on how to get value out of all of us.

Exit strategy: Kevin: Definitely not deal by deal. We invested in a towing company, our first deal. It went awesome. His brother ended up wanting to buy a towing company. They're going to roll it up and they've already got a PE buyer waiting in the wings. He was planning to hold the company forever and just recap us out, but things happen. Be opportunistic.

Tony: I try to confirm I'm aligned with the searcher on a path to exit in five to seven years. That can come in three flavors. First, the searcher explicitly wants this; if the business is doing well, they have a ton of net worth tied up and want liquidity. Second, I want to know who else is on the cap table to understand if they have the cash and interest to potentially buy me out in five to seven years. Third, the most explicit, is putting a put option in the agreement allowing investors to sell shares back, assuming the business has the cash flow, at fair market value at year five or seven. I've been pushing for that latter because it's explicit and fair and eases the ability for larger investors and funds to invest in deals.

Do funds compete? Kevin: When I was raising and Ben was raising, the funds didn't exist. It was all individual investors. I don't view us as competitors. I started a Slack channel with a couple other funds. Rising tide lifts all boats.

Tony: If I'm going to invest, I want confirmation this makes sense. First I go to my LPs and offer the deal. If there's still room, I want to share with other really good investors. It's good for the business to actually have other smart investors on the cap table. It is somewhat self-serving. We're on cap tables together.

Convertible debt: Tony: It doesn't exist in our space. The reason convertible debt existed in startups is there was an active angel ecosystem and a way to price deals without spending money on attorneys. It's technically debt in the short term, but no one investing on a convertible note in the startup world thinks of it as debt. They think of it as a cheap way to price equity. I don't know if that mechanism is needed here, or because there is debt in this world. As an alternative to SBA, it's hard to compete with SBA.

Lisa (audience): Our credit group's current interpretation would not see convertible debt as eligible.

Kevin: We're getting participating preferred equity, which has a similar economic payout structure as a convertible note.

SBIC and other structures: Ben: The SBIC funds I've talked to have a $2 to $3 million EBITDA minimum size. They're not coming down. If you've got a larger deal, that's who you want to talk to.

SBA debt as investors: Tony: Because of the flavor of deals I like, more conservative, a business that's been very consistent in revenue, modestly growing, the only way to get the 35% return I'm looking for is if it's levered. What I love about SBA debt is it's high leverage, and SBA lenders do a lot of work to scrutinize the deal to ensure debt service can be paid. We're going to lever a business that's very consistent and enhance the returns. I'm somewhat agnostic as to whether it's SBA or other forms of debt; I love the high leverage.

Kevin: We'll do independent sponsor deals, but there's nothing like signing a $5 million personal guarantee to know somebody has skin in the game. I value that very highly. It aligns our interests as investors with the searcher. An investor in my cap table commented there's something compelling about somebody willing to push all the chips in the center on a textile furniture company in North Carolina, pick up and move his family, completely change his life to make it happen. A lot of searchers are doing that. That's the difference with other debt; there's no recourse in some other debt. As we go up market, I really like this space because you've got real skin in the game.

Ben: It's effectively government subsidized debt, and you've got people all in with the PG.