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Exits: The First Evaporations

Paul Clark
Paul Clark
Last updated: June 4, 2024
Venture south fallback

There are a few immediate claims on the water heading into the waterfall; some of these are fairly obvious, others are more complicated or controversial.

Transaction fees

Investment bankers, attorneys, accountants, advisors, and other service providers that have helped to make the exit happen get paid first for their services. These “transaction fees” can be substantial, with often several percent of the consideration going to pay those who have contributed to the transaction.

We generally recommend using an investment banker to drive a competitive exit process, as these generally lead to a higher acquisition price and a lower burden on management’s time and impact on the business. These benefits, though, come at a price. Though it varies, you could budget 5% of the transaction value, which can be several hundred thousand, potentially millions, of dollars, to these fees.

(Incidentally, if you need connections to good southeastern investment bankers, let us know – we work with our favorites frequently.)

Debt repayment 

Next comes debt.

First come all those payables a company builds up over its history. Loans from founders or employees; employer taxes payables; kind payable terms your in-house counsel has given you over the years. All these liabilities come due, and all this informal credit gets called, because the company can at last pay it off!

At the same time comes formal secured or unsecured debt, like bank or SBA loans, funding from the NC Biotech center, or other investment loan programs. More recently, programs like PPP funding or EIDL loans have added to this list.

Then comes outstanding convertible note debt. While the goal of convertible notes is to convert into equity, if simply getting repaid gives the noteholders more proceeds then that’s what they can do. (Our convertible note guide explains how notes are essentially a senior liquidation preference in many scenarios.) If paid out, noteholders get principal and interest, plus any other bonuses (like a 2x change of control premium) to which they are entitled. (This probably doesn’t apply to the $100 million exit, but for <$20 million exits it could definitely soak up a lot of the proceeds.)

All these get repaid from the water flowing down the waterfall first, because debt is “more senior” than equity in waterfalls.  

Working capital adjustment

Transactions almost always need to adjust for a “normal” level of working capital in a business, and this adjustment typically reduces the headline price.

Countless hours are spent trying to figure out what a “normal” level of working capital is. The precise complications and calculations are too arcane even for a VentureSouth blogpost, so let’s just say for now that, as an investor in the selling company, you will probably find that these adjustments end up making money disappear from your proceeds! Regardless of the details, the Golden Rule applies: when you invested, you had the gold and made the rules; now the acquiror has the gold, they make the rules.