Self-funded Search Investing Report: Breaking down the average capital stack of a small business acquisition

When acquiring a business, structuring the capital stack is a critical step to balance the risk involved in funding a transaction. This article explores the average capital structure breakdown and the common financial tools used by acquirers in small business acquisitions.

Capital structure breakdown

The average acquisition capital structure typically includes a blend of the following components:

• Senior debt (60%): The majority of acquisitions are financed with debt, allowing buyers to pathway to successfully transacting and the potential for attractive returns on their capital.

• Preferred equity (20%): Investors often contribute preferred equity, offering them priority returns while ensuring the acquirer retains operational control.

• Deferred consideration (16.7%): Sellers frequently agree to defer a portion of the purchase price, allowing buyers to manage cash flow effectively post-acquisition.

• Sponsor equity (3.3%): Acquirers contribute a relatively small percentage of their own equity, leveraging other sources of capital to fund the deal.

Key ranges of capital structure components

1. Senior debt: Senior debt typically constitutes 40%–80% of total capitalization:

   • <40%: Uncommon and used in less leveraged deals.

   • 40%–60%: A frequent range of debt capital for both self-funded search and independent sponsor deals.

   • 60%–80%: The most common range, balancing risk and financing efficiency.

   • >80%: Rare, as excessive leverage increases financial risk.

2. Preferred equity: Preferred equity investments vary significantly but are often within the following ranges:

   • <10%: Present in roughly one-fifth of transactions.

   • 10%–20%: Represents the majority of preferred equity allocations.

   • 20%–30%: Less common but may apply to high-growth or higher-risk opportunities.

   • >30%: Rare, depending on the structure of the deal and the investor's terms.

3. Deferred consideration: Deferred consideration is an essential tool, typically comprising up to 25%+ of capitalization in many cases. This includes:

   • <2%: Uncommon, occurs in deals where the seller wants to be paid up-front.

   • 2%–10%: Occurs in deals where the seller is willing to hold a note and help the buyer out in completing their capital stack.

   • 10%–25%: Most common, offering sellers a gradual payout while minimizing buyer risk.

   • >25%: Common in transactions where sellers remain invested in the business’s success post-sale.

4. Acquirer contribution (sponsor equity): Acquirers typically contribute 2%–10% of the total deal value:

   • <2%: Minimal contribution, relying heavily on other funding sources.

   • 2%–5%: The most frequent range for sponsor equity.

   • >10%: Seen in cases where the acquirer wishes to minimize external equity dilution.

Strategic insights

1. Balance between debt and equity: Acquirers generally fund 40%–80% of transactions through senior debt, which can provide investors with leveraged equity returns.

2. Deferred consideration benefits: By deferring part of the purchase price, sellers align their interests with the acquirer’s success, reducing upfront capital requirements.

3. Tailoring capital structures: Flexibility is essential—capital structures should align with the target business’s risk profile, growth potential, and cash flow dynamics.

Conclusion

The capital structure of a business acquisition is more than just a financial strategy; it’s a roadmap for balancing risks and maximizing returns. Understanding the typical breakdown of senior debt, preferred equity, and deferred consideration can help acquirers and investors negotiate tailored financing solutions for their deals.

Whether you’re an operator looking to acquire your first business or an experienced investor searching for a deal to back, understanding the optimal capital stack is key to achieving your own goals in an acquisition.

Interested in more? Download the full Self-funded Search Investing Report for a full breakdown on the investing landscape.

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.