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Structuring micro-acquisition deals creatively for maximum cash flow & IRR

"We're starting a SPAC." —Thomas Edison

Eyal Toledano

Mar 12, 2021

In the lifecycle of a micro-acquisition project, the initial acquisition is the stage where the most cash is at stake.

There’s a saying: “You make money when you buy, not when you sell.”

It’s usually intended as a means of emphasizing how important it is to pay the right price for your acquisition, but it’s also applicable to the amount of cash you put into the deal.

As it turns out, the amount of cash you put into a deal has a huge impact on your cash-on-cash returns.

That’s why you want to be structuring deals creatively — so you can decrease your cash position while earning the same dollar-for-dollar returns relative to the purchase price.

As you consider the range of possible products you could acquire, keep in mind the cash position you want to be taking upon entry, as that will define the type of options you will have to use in order to secure a transaction.

There are a bunch of options at your disposal.

All-cash

The first, most obvious instrument at your disposal is liquid money. Cash is King because it knows no boundaries and isn’t limited by any constraints.

Your base spending power is powerful in its own right.

It contains the ability to immediately secure an asset, fully own all of the equity in it, and thus reap all of the ensuing benefits from ownership.

For an investor who’s conscious about cashflow and control, nothing beats cash.

However, cash is also the most difficult thing to come by, and in many cases, the most expensive asset to field.

Not everyone’s been blessed with a large, seven-digit outcome. Even then, $100k or even $1m today just isn’t all that much money. It goes really quickly if you’re making any kind of real move.

For that reason, cash is something you want to be conserving. It provides the ability to create leverage by leveraging the cash as a guarantee.

One might ask: “Why pay something all cash if you could get debt against it, buy an asset with a smaller cash position, and therefore secure larger cash-on-cash returns?”

That’s a solid consideration for someone who’s not concerned about optimizing the absolute cash flows, as I currently am.

Yes, you could go in with a smaller cash down, but you’ll have to make up the gap elsewhere, and that likely means debt you’ll need to service, which will eat into your margins and ultimately, your bottom line.

It’s totally a question of style and what your goals are.

But the main idea is to either conserve your cash as much as possible, or to make it your number 1 advantage. Don’t teeter on the edge, then you’ll only reap the inconvenience of both:

Spending your cash reduces your leverage and possible debt
You may not be in a position to secure a similar lump sum until some other unknown point in the future (a point which grows with the amount)

The thing cash gets you that others don’t is speed.

Speed can be everything in a deal.

I recently withdrew from a transaction that would have been a great investment.

I was buying $3k MRR at a 2.05x multiple.

The trouble was the product growth was stagnant and I didn’t see myself adding a ton of features to the product.

Busy doing that with Batch, which I’m far more passionate about.

The only reason I managed to land a signed LOI at 2.05x is because I moved incredibly fast: all-cash offer in 3 days, LOI signed in 5 days.

The seller could see the money landing in their account the following week (it would have).

I made an ultimate commitment to field up to $500k of my own cash to secure a 2.7x return created by strong cashflows and an eventual 2x return once the fund matures end of Q1 2023.

I did this because:

I know I need to move fast to secure the best deals
I want to keep full control over the purchase and operations
I don’t want to hold any debt that drives down profitability

Doesn’t mean I wouldn’t use any of the below instruments to land a deal. I’m just really inclined not to, and have the purchase power to retain that optionality as an investor to make the best out of the deals I come across. I can open all doors.

In fact, I’m currently midway in diligence to secure a ~$400k acquisition. Right now, I’m looking at the following terms:

$300k cash
$100k convertible note

I could go all-cash, and it would still be an amazing move.

But I’d like to retain at least a little bit of cash, especially if I can meet my MRR and IRR goals without fielding everything.

Then I’d have leftover I could either (1) keep and instantly increase my fund’s returns from investing less than 500k, (2) reinvest into my existing portfolio and/or (3) potentially make one equity deal such as a SPAC participation.

These many options are viable because liquidity is the number one asset at your disposal.

We’re also exploring some equity, revenue-sharing + of exit (equity without rights) and seller-financing. It’s going to depend on what works best and of course, my upper limits with all-cash.

Cash is obvious at first thought, but it’s important to get a grip on just how much power liquid cash affords you when you compare them against all of the other tools.

Earn-outs

The frank truth is most entrepreneurs hate earn-outs.

I’d say no to most earn-outs because the basis of an exit is to leave. I don’t want to have to stick around. This is a micro-acquisition.

An earn-out assumes a percentage (or potentially all) of the transaction’s amount is earned over time, and likely paired with conditional milestones the seller must meet to satisfy the earn-out and collect their money.

Typically, this is used at a higher level for larger transactions where the team is an important component.

In a micro-acquisition, you’d be hurting the deal by offering this option because it ties the hands of the seller after the acquisition.

Don’t get in the way of the seller and their moon.

That said, there obviously will be situations where this is a justified mechanism to use.

Use your judgement and consider the reaction the seller is likely to have when you tell them a percentage of your offer is contingent on sticking around.

That’s going to lose really quickly to an all-cash offer, for example. You need to ask yourself if using this term in your consideration is in the best interest of the deal.

Perhaps you could introduce a 5% or 10% earn-out which is directly tied to the 90- or 120-day support period. Be creative.

If your own hands are tied and you don’t have a lot of options to play with, then just play your cards as they are. The point would be moot.

Seller financing

Perhaps one of the most popular ways of closing the gap on an mostly all-cash deal is by getting the seller to finance a percentage of the transaction.

This sounds really complicated, but in the real world it generally translates into equal payments over 12, 18 or 24 months.

I’ve used decreasing ladders in the past, where I’ll front-load 80% of the cash balance in the first year and the other 20 + 10% bonus in the second year.

That allows the seller to walk away with more of the final purchasing price earlier, while also kicking back a bit extra for the trouble.

What I like about seller financing is that it counts as equity in your deal. If you’re trying to combine several pieces like:

Some cash
Some seller financing
Some lender financing

You’ll be advantaged by a large cash balance because the lender will count that as funds that are being injected.

It’s your cash + seller financing. If you can make sure that’s 30% or more of your purchase, there’s a strong chance you can get your loan. If your seller is cool financing, you’re off to the races.

Otherwise, for a mostly cash deal, it’s the way to ensure the seller remains in the picture without muddling the terms.

Something I’ve noticed is that the vast majority of sellers in micro-acquisitions don’t have a big issue with a small cash balance.

The issue is long terms. They don’t mind a year. Two is annoying. Three’s a deal-breaker and four’s an insult.

Paying interest or a bonus is a great way to get the seller to agree to finance you a portion of the deal.

At the end of the day, being up-front about how much cash you can afford to put up goes a great way to humanizing the deal and earning some good faith.

If you can be transparent about what you’re after, what your scope is, and how you’d be prepared to orchestrate different options to close the deal, I’m confident you’ll find a seller who’s more than willing to work with you.

It is, after all, in their best interest.

Bank financing

I think this is probably the most complicated one of the lot.

Beyond the fact it’s usually prohibitively slow, the documentation burden you have to endure to secure financing for an institutional partner is absurd.

At the micro-acquisition level, most buyers are going to be using pretty crude means of analyzing different opportunities on the basis of how early most of the products are.

They’re operated by individuals who leverage Shopify, Stripe, PayPal and other ubiquitous digital products and services that make it incredibly easy to qualify revenues accurately.

There’s huge value in writing up business plans.

But in my opinion, there’s more value in taking action.

The amount of velocity one can get from keeping in touch with customers in real-time is impossible to beat. And banks just don’t subscribe to this way of thinking.

If you mention to the seller that you’re working with a bank, you may jeopardize the deal solely on the basis of the fear you’ll instil that this is going to take forever to materialize.

Something I’ve tried doing in the past is working with a private bank that had financed me before on larger, venture tech startups.

The idea is simple:

Since I have an existing relationship, the investor/entrepreneur fit doesn’t need establishing
I could communicate to my lender what my investment criteria are, and synchronize them with his own lending criteria
When I find a new lead that fits my criteria, the lender would fast-track the process by simply confirming, rather than researching.

That’s unlikely to ever happen with dinosaur banks, though.

Lender financing

An alternative lender is a different story.

If you can work with someone who understands technology, understands SaaS, and has an appetite to finance highly profitable businesses that other banks will undoubtedly skip on, then you’ve hit the jackpot.

You’ll gain access to 5-7 year term loans, which have very little impact on cash flows, and by that simple standard represent a far more interesting mechanism than seller financing (i.e. 12 months), which will rip your Year 1 profits to shreds.

The typical interest rates vary between 5% and 10%. I’ve worked with the BDC in the past. They’re professionals with an incredible history. I wouldn’t work with much anyone else.

And yet, I’ve not sent them a deal in a little while because the last one I did was lost due to needless back-and-forths on needless documentation.

I respect the way the world works, but I try to avoid its worst or most inconvenient aspects when and where possible.

If you’re a private lender who moves fast, gets micro-saas and you want to work together, hit me up, I’d love to link up.

Convertible debt

The idea of a convertible note is simple.

At the basis of it all, it’s a loan just like any other.

It has interest rate terms and a date at which the loan matures and must be paid back.

The big difference is that when the loan matures, the amount owed could conceivably be converted into equity, instead.

A convertible note defines both the loan terms, as well as the cap table impact caused by converting the debt to equity. It clearly stipulates the price per share and the number of shares.

If you offer convertible debt to the seller, you do a few interesting things that can make it an attractive alternative to seller financing:

For starters, you may not be paying monthly, though you need to save up for the loan maturity (some convertible debts have monthly principal payback)
You provide upside to the seller because they can choose to forego the rest of the purchasing price (the convertible note portion) provided it is worth more to convert the note than it is to collect on the loan’s principal.
You largely retain the attention of the seller as they will have a vested interest in seeing the company continue to grow post-acquisition, leading to a higher chance of their potential equity being worth more than the outstanding loan.

Master lease agreements

Basically, this agreement provides you with an “equitable title” which gives you all the rights typically associated with ownership, including the right to keep the cash flow and reap any tax benefits.

You don’t actually own the asset, but the agreement usually gives you the right to acquire the asset outright under some specific terms at some point in the future.

In exchange, you’d make monthly lease payments to the owner, who in turn would use these payments to pay off any debt and increase their equity.

I think this has a huge potential to take off in the future.

Consider a microangel who buys a $150k Micro-SaaS which reaches $20k MRR.

Amazing! But now, hard to run alone.

A talented team comes along and agrees to pay $60k/yr for 3 years in exchange for equitable title rights.

The micro-angel uses the $60k/yr to pay off the loan from the acquisition while the business continues to grow under the other team, who has the right to buy the business 3 years later on at terms that favour you as the micro-angel.

At which point you’ll have paid off all of the debt without doing any active work. You’ll own all of the equity, and be in a position to sell a $20k MRR / $240k ARR business 3 years later to a guaranteed buyer, for a guaranteed multiple.

This is the mother of buy and hold, and it could provide incredible benefits to indie hackers who are trying to go FT on a project, but don’t necessarily have the funds yet to acquire it out right.

This would work out to a win-win for both parties and a wonderful ecosystem flywheel that all benefit and grow from.

Just like BRRRR, this is one of my favourite models to consider for Fund II, or III. They’re deliberate with guaranteed results.

Assuming the seller’s loan

Pretty self-explanatory, but it is worth noting this only works if the person you are trying to buy from is already holding a loan.

The odds of this happening in micro-acquisitions is very low.

I’d say once you’re past the $200k ARR threshold, then it’s possible someone would have secured some debt to acquire the product, and would still have an open loan at the time of sale.

In this model, you’d simply offer to take over the loan.

That’s a nice mechanism because it effectively slashes the acquisition price by the amount currently outstanding in the mortgage.

You’d simply find a way to pay the difference.

Imagine being able to assume a seller’s loan and then use some of the free cashflows to service some seller financing on top of that.

You could basically just take over for someone who’d get an immediate cash injection while ridding themselves of debt.

Wraparound loans

This is a bit cheeky.

In this play, the seller keeps their existing loan in place after the sale. They don’t pay it off, and they keep it in their own name.

But as part of the deal, you as the seller extend to the buyer financing for a larger amount than the underlying mortgage amount.

In effect, this make the buyer responsible for your debt moving forward plus some extra debt.

Basically you wrap around the existing loan with owner financing.

I don’t love this type of stuff. Arbitrage has its place, but meaningless cost-plus strategies are anything but strategies.

We’re not out here to try taking advantage of people. The entire point of all of this is that bootstrapping, unlike venture, isn’t a zero-sum game.

New ideas come out all the time, and they have intrinsic value, whereas a VC will not assign any value to a product without the potential for a huge outcome.

Treat your peers with respect.

We’re all buyers and sellers at some point in the lifecycle.

Combinations

Naturally, I encourage you to play around with many of the above and to build scenarios about how things would work out if you use one, some or all of the above mechanisms.

Stay cognizant of the fact that complexity hurts your deal, and resist the urge of creating a Frankenstein out of your terms.

If your LOI is scarily complicated, just kiss your deal goodbye!

Syndicates & Special Purpose Acquisition Companies (SPACs)

All of the above strategies help you structure a deal with maximum value with the least amount of cash while balancing your risk.

In an ideal world, you only use your own cash to pay for whatever your down payment ends up being.

The greatest benefit is that you retain full control over the business but you get to reap 100% of the return on the total value.

So what do you do when you don’t have enough cash?

Or even zero cash?

Since you can’t secure funds through debt because you have no cash for down, you can look to equity, or more specifically, syndication.

The idea is simply to pool together partial ownership from other investors in exchange for their cash contribution into the acquisition.

Now we’re talking about equity participation, profit participation, acquisition fees and so on.

You’re basically running a one-time fund. I don’t know yet if this will be feasible to someone without access to a network.

AngelList is perhaps the most well-known destination for “special purpose vehicles” like syndicates:

A syndicate is a VC fund created to make a single investment. They are led by experienced technology investors, and financed by institutional investors and sophisticated angels. Syndicates are private. Investors can participate by applying to back a lead or investing in a fund

Not gonna lie, it sounds really elitist, but the model is sound.

This is a huge opportunity to make possible new connections between microangels for the purpose of syndication. Wink wink.

Special purpose vehicles like syndicates are going to really take off as the number of microangel grows. I want to work and invest alongside people who think like me and are as ambitious as I am.

I have a strong feeling that Fund II LPs will mostly be comprised on Twitter friends, indie hackers, PE fund operators and MicroAngel subscribers. That would be awesome.

Special purpose acquisition companies (SPACs) are the latest innovation that microangels and bigger investors could use to raise funds for the purpose of acquiring one or many companies, and pursuing the mission of taking that fund or company public.

Because the point of a SPAC is to go public, this is pretty much guaranteed overkill for a Micro-SaaS. But, I think it could be a fantastic model for a micro-acquisition fund whose purpose is to go public.

I can tell you I have that aspiration with MicroAngel given the unbelievable amount of interest I’ve received from across the world to do very much that. Never considered it, but now it’s something to look forward to deeper into the future.

Most of the idea isn’t new at all and is pretty much the same as a syndicate. The company formation is all that really changes. And obviously the financial and legal infrastructure required to operate a public company down the line.

The main difference I find between a syndicate and a SPAC is the distribution of responsibility:

In a syndicate, the sponsor who raises the fund does 95% of the operational work associated to the activities. The investors simply contribute capital and then expect a return by maturity
In a SPAC, I would expect there is still a main sponsor (maybe the CEO), but the work is much more evenly distributed so as to take advantage of the presence of multiple shareholders, minus public shareholders when the SPAC is taken public

Creating a SPAC is a whole other job.

I don’t think you’re the same after you’re a SPAC, especially if the point is to go public. It’s a totally different game with far more minute details that, most will agree, is just too much.

The play might instead be to create master lease agreements that enable the SPAC to hire a team for each of the products without losing any of the IRR upside.

If the fund cares about cash flow returns, this might not work considering that master lease agreements yield all revenue benefits to the leasee.

Instead of a SPAC, which is again absolute overkill despite being the hyped thing of the day, it’s entirely possible to create a syndicate for a single deal and reap a variety of advantages:

You reduce the required cash position
Since others are joining, they work on the product too, reducing the amount of work you have to take on
Provided the investors have complementary skill sets, a compounding force is created towards successful execution
The product benefits from a multiplied network at the onset
Decision-making is polished using the investor’s experiences

You may benefit from decentralizing the work and distributing it, but the very exercise of managing a fund and its shareholder relationships isn’t necessarily something you’d want to commit to in exchange for product focus:

Find your partners
Agree on your objectives
Work out your investment strategy
Determine the investment structure you are going to use
Agree on your acquisition criteria
Put a legal agreement in place
Execute

Oh, if only there was a way to do all this stuff online without the legalese. Wouldn’t that be great?

As that becomes possible and gains adoption, I suspect people like me will start to utilize the relationships they’ll have built throughout their careers to involve friends and colleagues into deals.

For every indie hacker and microangel who’s willing and able to make the jump, there are 100 others that are inspired by the journey but unable to partake for a reason or another.

A company built on the premise of acquiring other companies could become yet another avenue of entry for people wanting to participate without having to actively contribute.

This is also true of anyone outside of the world of technology that wants to join potential winners without having to drink the Silicon Valley koolaid

Real estate folks are flocking to software because the numbers are really attractive, but the skill involved in a high tech venture is considerable.

Indie hackers are truly talented folks. They’re one-man armies.

Their current journey is the continuation of years of practice and improvement across several disciplines leading to the creation and growth of a subscription-based digital product.

Hopefully, SPVs are going to fill that void by enabling limited partners to enjoy the benefits of bootstrapping and investing in Micro-SaaS products for freedom and profit.

In the meantime, take stock of the tools at your disposal where it comes to micro-acquisitions.

Your cash-on-hand goals determine much of the approach you’ll have to take, and you ought to be deliberate about your limitations so you can work around them.

You can only be prepared for every deal you approach if you are intimately in touch with the tools at your disposal.

A surgeon confidently walks into a surgery room, looks at the patient, recognizes the first procedure, and selects the appropriate tool for the job.

Be incisive with this specific part of your thesis, and you’ll find yourself fumbling way less when it comes to structuring deals creatively because you’ll know what tools you’re working with.

What are other ways you could structure a Micro-SaaS deal?

Let me know below or on Twitter!

Eyal Toledano @EyalToledano

What are the different ways you could structure a micro-acquisition? - earn-outs - seller financing - bank financing - lender financing - convertible debt - master lease agreements - syndicates - SPACs 🤓 - combinations of above What else?

Next time, I’m going to share my micro-acquisition process from first-touch to closing & asset transfer. Subscribers only.

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