An example capital stack...

The biggest limiting belief I see from guys wanting to buy a business is "I need millions of dollars to buy it".

I can harp on and on explaining different funding mechanisms or sources of funding, but unless you see it in action, that means nothing.

So what does the capital stack ACTUALLY look like for a $5m revenue acquisition?

I'm going to lay this out as though I'm doing this in Australia or South Africa. Here, the banks are FAR more conservative than the US. A deal like this would be EASY to do in the USA with an SBA loan paid back over 10 years. That's why multiples are higher over there.

Firstly, some deal parameters:
- The business is doing $5,000,000/yr in revenue
- It's net profit margins are 20%, or $1,000,000/yr

The seller is asking $4,000,000 for the business. This is high. It still works. Watch...

The capital stack is nothing more than the 'layers' of funding used to close the deal. Here's the exact stack we would use for this $4m deal.

Layer 1: Senior Debt (60%)
- In the most conservative cases (such as South Africa, with 15% interest rates), the banks are comfortable, in my experience, lending up to 2-2.5X debt to EBITDA. That means as a ratio of profit, on this deal, they would give you $2,500,000.

"Oh but you need security to get the money"...

Sure, if you want to approach the bank on your own, as 'Bob, the guy who wants to buy his first business', then they will want the debt to be 100% collateralised. That's because they don't have faith in you, because let's face it, you're retarded. This is also why the board is critically important. In addition to the board, we have a reputable accounting firm to the due diligence and provide a quality of earnings report. By taking these steps, the bank's attitude has completely changed. You should check my other posts for info on building a board.

If the business has assets to back some of this debt, that obviously helps. Think equipment, machinery, etc.

Layer 2: Seller finance, or earn-out (20-40%) - $800k-$1.6m
This is money you pay back to the seller over time. If you are already stretched, in terms of affordability with the bank debt, then you won't be able to take more debt on with the seller. If you can get them to agree on 10+ years, then this shouldn't be an issue. If you can't, just do this...

Instead of paying them monthly, pay them an earn-out or balloon payment at the end of year 3. At that point, you'll go back to the banks and refinance the original debt you took, to take an additional $1,000,000 to pay the seller. The banks will only give you this money if the business is doing well, which is why you tie the payment to performance.

Layer 3: Retained/Rolled equity (20-40%) - $800k-$1.6m
An alternative to layer 2 could be retained equity by the seller. I LOVE this approach. It keeps the seller in, and invested, until they make a full transition out. They have skin in the game, want to grow the business so that their buy-out at the end is bigger, and the banks see there is clear equity on the balance sheet.

That means that when you are speaking to the banks, and they ask "how much equity is going into the deal?", you can tell them - 30%. This ticks a huge box for them, and also de-risks the deal for them, as the seller is staying involved. To pull that off, you also need a solid board/team/vision, as the seller must buy into the fact that the next 3-5 years of their life will be better off with you in it.

And there you have it. That's exactly how the deals that we do look:

1/ Bank debt (60%)
2/ Seller finance/earnout (20-40%)
3/ Retained equity (20-40%)

It ticks all the boxes with the banks. It's seriously that simple. And we're doing it. I had a bank, just last year, offer me $2,500,000 for a $4,000,000 acquisition last year with this structure.

Unfortunately the deal fell through, because we found their EBITDA had dropped in the most recent year's financials, and they didn't want to re-cut the deal.

But I can guarantee you, that this is doable, in the most conservative banking market in the world.

The ONLY hard part about buying a business, is finding the RIGHT one. Once you have the right opportunity on the table, the rest falls into place. That is the ONLY moving part.