Legal Considerations in Self-Funded Search Fund Transactions with Jake Parsley

In this episode of The Transaction Abstract Podcast, Joe Hellman speaks with Jake Parsley, a partner at SMB Law Group specializing in search fund transactions. They discuss the specific legal hurdles self-funded searchers face when acquiring Main Street businesses.

The Self-Funded Search Landscape

Self-funded search funds often involve first-time entrepreneurs acquiring businesses valued at less than $5 million. They use a combination of Small Business Association (SBA) financing, seller notes, or investor capital. 

Unlike traditional search funds with institutional backing, self-funded searchers work with Main Street advisors and manage much tighter acquisition budgets.

As Parsley explains, "When you're doing a deal for $2, $3, $4 million, the acquisition budget probably just isn't there like we would like, like we'd like to see in a perfect world." 

Searchers must choose carefully where to spend limited resources while still protecting themselves from major risks.

Critical Risk Mitigation Strategies

Three important elements protect buyers in these smaller transactions:

Financial diligence comes first. Start with the numbers. Financial diligence is non-negotiable for any deal size.This groundwork helps identify problems before they become expensive surprises after closing.

Seller notes give necessary protection. With SBA loans restricting earnouts and recent changes limiting rollover equity, seller notes have become the main tool for bridging valuation gaps. 

"The biggest seller note that you can get, I'm an advocate for, because that's your first line of defense if something goes wrong," Parsley emphasizes. These notes, subordinated to SBA debt, align seller and buyer interests.

Right-sized legal documentation matters. Your purchase agreement should provide essential protection without being too complex. Parsley stresses "capturing the things that are fundamental to the business operations, working out a good, clear working capital clause where both sides know what's coming and we can have clarity on that before we close the deal."

Advice for Searchers

Timing your legal engagement can save a lot of money. Parsley recommends a specific sequence: "Get your LOI (Letter of Intent) done, get your financial diligence done, get your financing lined up, then engage legal." He explains that many Main Street deals fall apart, and "we hate to see you spending money on lawyers, even if we're the lawyers."

Flexibility is your best friend. 

"Not everything is going to go the way that the Harvard Business Guy Just Buying a Small Business says it's going to," Parsley advises. "Keep an open mind and be ready to pivot a little bit. That flexible open mind will not only serve you well through the buying process, it's gonna help you once you're operating too."

Key Takeaways

• Financial diligence and seller notes are the two most important risk mitigation tools

• Find attorneys familiar with SBA transactions who understand both protection and practicality

• Engage legal counsel after securing the LOI, completing diligence, and obtaining financing

• Flexibility throughout the acquisition process improves success rates

Listen to more episodes of The Transaction Abstract Podcast on buying and selling businesses.