Need-to-Know Financial Information Made Simple

What is a Finder’s Fee?

What is a finder’s fee? When used correctly, finder’s fees benefit all parties involved. Often, without an intermediary earning a finder’s fee, a transaction between two parties would not occur. This post explains what a finder’s fee is, how it works, and includes a finder’s fee agreement sample.

Finder’s Fee Meaning

A finder’s fee, also known as a “referral fee” is a way for one party to compensate another for a referral. The earner of the fee, or “finder,” typically provides an introduction of two parties (often a buyer and a seller) who did not previously know each other. Because the introduction is potentially valuable to at least one party, one or both of the parties are willing to pay a fee for the introduction. Hence the term Finder’s Fee.

Most finders’ fees are contingent upon some event or transaction actually occurring. In other words, the finder is not compensated until/unless the parties find the introduction valuable and complete a transaction. Upon the official transaction, the finder earns the fee.

Finder’s Fee Agreement

While it is possible that a finder could have a verbal arrangement with another party, they are usually documented in a written contract. For example, if you have a friend who would like to sell his mint condition 1972 Chevrolet Corvette, he might agree to give you a $5,000 finders fee if you bring him a qualified buyer and the transaction closes. A transaction like this might be a handshake agreement and there is no need for a written contract. On the other hand, if your neighbor wants to sell his $100 million company, and you know a potential buyer, finalizing the terms of your engagement in a written contract is an important step in the process.

Who Pays the Finders Fee? The Buyer or the Seller?

Either one! The Finder typically enters into a contract (“Finders Fee Agreement”) with either the buyer or the seller. In rare cases, the Finder might enter into a contract with both the buyer and the seller.

What Is Included in A finder’s Fee Contract?

Please see the sample Finder’s Fee agreement at the end of this post. A finder’s fee contract includes key provisions including but not limited to:

Names of all parties involved

Length of the contract

What services are being provided and what has to occur for the fee to be earned

Confidentiality and non-circumvention

How is the fee calculated and paid

How are Finders Fees Calculated

Finders Fees are negotiated between the parties in the agreement. The fee is generally aligned with the value of the introduction and the value of the transaction. When selling a business, the Finder’s Fee is frequently based on the Lehman Formula. See the example below for a Fee Agreement that utilizes the Lehman Formula.

Does Private Equity Pay Finders Fees

Yes! Private equity firms regularly enter into buyer paid fee agreements that are are paid upon a successful transaction closing.

Finder’s Fee Agreement Sample

Note: This is an example of a Finder’s Fee, and it is not intended for your use. 1719 Partners is not providing legal advice. This sample agreement uses a Lehman formula.

This Fee Agreement (“Agreement”), dated as of [insert date here], sets forth the terms and conditions upon which [insert finder name or legal entity here] (“Finder”) shall act as non-exclusive finder for [insert buyer or client name here](“Client”) and/or its assigns for two (2) years from the date hereof (“Term”). In such capacity, Finder shall introduce representatives of the Client to the owners and senior executive officers of [insert target company name here] (“Target”)and shall obtain and provide information regarding the business affairs and prospects of Target, including detailed financial statements and any other information reasonably requested by the Client, in connection with any due diligence investigation Client may undertake (the “Services”).

Client hereby engages and agrees to cause Finder to be compensated if Finder’s introduction to Target during the Term results in Client purchasing 25% or more of the capital stock of Target, or all or substantially all of the assets of such candidate, within 24 months of the date Finder introduced such qualified investment candidate to Client (a “Transaction”).

In consideration of Finder’s provision of the Services, if a Transaction is consummated, a finder’s fee (the “Fee”) shall be paid, or caused to be paid, by Client to Finder on the day of the closing of the Transaction, such Fee to be based on the Purchase Price (as defined below) paid by Client in connection with the Transaction. Such fee shall be computed as follows:

5% of the first $1,000,000 of the Purchase Price, plus

4% of the next $1,000,000 of the Purchase Price, plus

3% of the next $1,000,000 of the Purchase Price, plus

2% of the next $1,000,000 of the Purchase Price, plus

1% of the balance of the Purchase Price.

The “Purchase Price” is defined as the aggregate consideration (whether in the form of cash, assumed debt or other non-contingent or non-deferred contribution of value) paid by Client to acquire its equity, debt or other interest in Target. In the event that any portion of the consideration paid by Client to acquire its equity, debt or other interest in Target is contingent or deferred, such consideration will be included in the Purchase Price.

For purposes of this Agreement, the term “qualified investment” shall mean an investment (i) in which Client or its affiliates obtains control of a corporation, limited liability company, partnership or other entity over which it did not have previously have control; and (ii) with respect to which Client has made no contacts with any parties related to such investment, has taken no steps to consider or pursue, has not learned of through any source other than Finder, and about which Client has no information. For purposes hereof, “control” of an entity shall mean the ownership of more than 25% of the equity securities of such entity, or the power to direct or cause the direction of the management and policies of such entity. In the event that Finder discloses to Client the name and address of Target that Client determines is not a qualified investment candidate, or if Client is already aware of Target, Client shall so notify Finder within five (5) business days of such introduction.

During the Term, the relation between Finder and Client is that of unaffiliated third parties. Finder and its officers, directors, employees and agents shall, under no circumstances, be deemed agents, employees, partners or representatives of Client.

Each party shall bear its own costs and expenses incurred in connection with the undertakings contemplated by this Agreement.

This Agreement shall be construed under the laws in the State of [insert state here].

This Agreement may be signed in counterparts, each of which shall be an original, but all of which together shall constitute one agreement.

IN WITNESS WHEREOF, the undersigned have executed this agreement on the day and year first above written.

Client: Finder:

What is a Finder’s Fee: In Short

In summary, a finder’s fee is a way to reward an intermediary for linking together two parties who otherwise likely would not have met. It incentivizes the “finder” to forge rewarding connections, as the finder is not compensated until the deal closes. If you have any questions on how finder’s fees work in private equity, 1719 Partners is happy to answer them. Simply contact us here.

15 February 2026/by Scott Dickes

Finance, Industry Insights

Financial Reporting in Due Diligence

Most business owners have a good grasp on their internal financial statements and ask their outside accountant to prepare the company tax returns. As a result, most business owners are less familiar with the nuances of their tax return, and may not be aware that the information in the tax return might be different than their internal financial statements.

A business owner recently asked me, “Why do you need to meet with my accountant and review the tax returns?” It’s a good question. Why review both the financial statements and the tax returns? Isn’t this a duplication of effort?

The answer is that the reconciliation between the two is a material aspect of due diligence. Tax returns are often more reliable than internal financial statements. They are prepared with an eye towards being audited by the IRS instead of just for internal use. The exercise sometimes brings to light useful information.

In addition, tax regulations and accounting regulations often differ on certain aspects. For example, the tax return may use accelerated depreciation whereas the financial statements may use a straight line depreciation method. This will create a book/tax difference. Also, many business owners are not accounting experts and might not fully understand the differences between the two statements.

I’ll give you a recent example:

During negotiations, the owner of a business said his salary was $150,000 and that he wanted to continue that going forward as an employee of Newco. This made sense to us and we agreed. We entered into a letter of intent based upon the company’s income statements which we assumed included the $150,000 salary. But what we learned after reviewing the tax returns was that the owner’s $150,000 salary was in fact a distribution and as a result, the $150,000 cost was not included in the income statements. So our understanding of the cash flow of this business was overstated by $150,000. Said another way, the $150,000 salary lowers EBITDA by $150,000. Using a 5X multiple, this equates to $750,000 of enterprise value. Not a small number. The owner wasn’t intentionally trying to mislead us, but without digging in and comparing the income statements to the tax returns this may have slipped through.

1719 Partners is an experienced buyer and understands the importance of thorough due diligence. If you are interested in selling your business and want to better understand the diligence process, or if you are a management team seeking to purchase a business, please contact us. We would be happy to share our thoughts with you.

15 October 2025/by Scott Dickes

Finance, Industry Insights

What Is an Earnout in M&A?

If you are considering selling your company, it is important to know an earnout is an option. An earnout can be the bridge between your asking price and what the buyer is willing to pay, allowing you both to accomplish your goals. Understanding how an earnout works allows you, as the seller, to consider all your options.

This guide explains what an earnout is, when it is used, how it is structured, and common pitfalls.

What Is an Earnout?

An earnout allows both buyer and seller to settle on a purchase price. In short, an earnout divides up the total purchase price into an immediate payment and a deferred payment. For example, if the seller believes his company to be worth $120 million and the buyer thinks its value is $90 million, an earnout can cover the difference. In this case, the buyer would pay $90 million upfront and structure an earnout for the remaining $30 million.

An earnout is also contingent upon the performance of the newly purchased company. In other words, there are strings attached. This motivates the seller to increase company performance post acquisition, which reduces the risk on the buyer. Company performance is objectively measured by key metrics that both parties determine beforehand. For example, these metrics can look like meeting a certain revenue or EBITDA margin, or retaining key customers.

Earnouts in M&A: When Are They Used?

There are many situations where using an earnout makes sense. For example, perhaps the seller has just acquired a big customer or launched a marketing campaign, and expects the business to exceed past performance. The seller believes the purchase price should reflect this advantage, while the buyer is skeptical. After all, from the buyer’s perspective, his or her concerns are valid: what if the big customer falls through, or the marketing initiative fails?

With an earnout, the seller receives down-the-road payments when the business does, in fact, meet expected performance goals. If the business does not, then the buyer does not have to make the corresponding payment to the seller. Below are some specific situations where an earnout makes sense.

Bridge a Valuation Gap

If the buyer and seller want to work together but do not see eye to eye on the purchase price, an earnout allows them to move past this hurdle. Another common way to bridge a valuation gap is using a seller note. However, a seller note is not contingent on company performance. While a seller note is nice because it gives the seller guaranteed later payouts, it does not allow the payments to increase based on company performance. Effectively, the payment cap is lower. This may be undesirable if the seller believes his or her company will perform highly in the near future.

Improve Ownership Transition

Passing the baton is not without risk. To reduce risk of company harm during the ownership transition, the buyer may want to include an earnout. This works because a later earnout payment motivates the seller to set up the company for continued success. In other words, the seller is financially motivated to see the company continue to perform, rather than simply wanting to “get paid and get out.” When the buyer and seller’s interests are aligned in this way, the company has more support to succeed.

Sell to the Right Buyer

Sellers often want to hand the business off to someone who will continue the business legacy. If the seller finds a buyer with a shared vision for the company, but the parties do not agree on purchase price, this can be disappointing. An earnout allows the seller to “have their cake and eat it too”— not having to sacrifice either purchase price or the ideal buyer.

If you are struggling to find a buyer who sees eye to eye on your business legacy and also has the capital to help you reach your goals, check out 1719 Partners. Our legacy is supporting your legacy.

Sell at the Right Time

There are many reasons why it may be the right time for the owner to sell. Maybe he or she is facing health obstacles or burnout, or it is time for retirement. Without an earnout, the seller would have to decide between selling immediately, and receiving a lower purchase price, or waiting a few years until the purchase price can reflect company growth. In fast-growing or newer companies, this issue is extra relevant. An earnout allows the seller to sell at the right time without sacrificing on future business gains.

Earnout Structures

There are many ways to structure an earnout. Earnouts should have a defined term, typically lasting one to three years. In addition to the term, performance metrics are also clearly defined. This reduces confusion between the buyer and seller. For example, the chosen metrics may be related to revenue, EBITDA, or customer retention.

Earnouts are also structured through percentages. For example, an earnout might be a percentage of revenue, revenue associated with key customers, or profits or EBITDA.

Earnout Calculation Examples

Exact earnout payouts are calculated based on the terms. In addition to the percentages mentioned above, earnouts have more detailed terms as well. These specific details limit the earnout’s maximum payments. For example, an earnout might have a lifetime cap of $1 million. This means throughout the earnout’s entire term the payments cannot exceed $1 million. Another structure might be 10% of revenue annually if the agreed-upon metrics are met that year, as well as a yearly maximum payout of $500,000, and a lifetime maximum of $1.5 million. This earnout may also end in four years. In addition, if metrics are not met one year, that year’s payment could be $0.

Common Pitfalls

As with any legal agreement, there are potential problems. In general, pitfalls are caused by nonspecific terms. Vague terms can look like an open-ended time horizon, no annual or lifetime payment caps, and more.

Typically, earnouts include a dispute resolution section. This provides instructions for handling disagreements, such as deferring to a third-party accountant or auditor.

Considering an Earnout?

Are you wondering if an earnout makes sense for you and your company? 1719 Partners has helped structure many successful transactions. We have seen earnouts play a crucial role in meeting both the buyer and seller’s goals. We understand that selling a business is a very personal process and situations can vary widely.

If you are considering a sale or have general questions about earnouts, don’t hesitate to reach out.

17 September 2025/by Scott Dickes

Finance, Industry Insights

Letter of Intent to Buy a Business: Protect Your Transaction

Entering into a letter of intent to buy a business is typically the first formal step in the process of buying or selling a company. Understanding a letter of intent, how it works, and what it includes is especially important if you are a first-time buyer or seller. This post will discuss several aspects of a letter of intent to buy a business, including why an LOI is helpful, key components of a letter of intent, and a few common pitfalls.

What Is a Letter of Intent?

A letter of intent to buy a business (“LOI”) is a legal document that buyers and sellers commonly voluntarily execute when they reach an agreement to purchase/sell a company. An executed letter of intent to purchase a business does not mean the transaction has “closed” but rather that the transaction process is “starting” and heading toward a closing.

In other words, the LOI serves as the bridge between a handshake-level interest and a definitive purchase agreement. For many first-time sellers, this is the moment when casual conversations turn into a formal process.

Why Is a Letter of Intent to Buy a Business Helpful?

A well-crafted LOI is a roadmap for all participants to get from “let’s do this” to a closing. The due diligence process and legal documentation can be stressful, especially for participants who are unfamiliar with them. The letter of intent helps outline the diligence process, key legal terms, transaction details, and other important components to ensure that all parties are on the same page and to minimize surprises.

A letter of intent to purchase a business does not need to be a 15-page mini purchase agreement, but at the same time, the LOI is unlikely clearly define the transaction if it is only a page or two and is silent on important topics. An appropriately drafted letter of intent is typically around four or five pages.

Think of it as a roadmap: the clearer and more specific it is, the easier the journey will be for both buyer and seller.

What Are the Key Components of a Letter of Intent to Buy a Business?

Confidentiality

Business owners are often very concerned about confidentiality and the reaction of customers and employees. LOIs usually reference that the terms of the transaction and the discussions themselves are confidential. There is also usually a several–year tail on the confidentiality period.

Exclusivity

Buyers will have to expend significant resources on conducting due diligence, preparing legal documents, and so on. As such, buyers commonly require exclusivity to invest this time, effort, and money in a transaction. Exclusivity typically means that the seller, once they have signed a letter of intent to sell their business, will not entertain offers or speak to other potential suitors while the existing letter of intent is in place. Exclusivity typically lasts between 90 and 120 days.

Timeline

The LOI typically includes a schedule outlining the timeline between the execution of the LOI and closing, as well as a timetable for achieving major milestones or hurdles, such as securing debt financing.

Transaction Terms

The LOI contains all key transaction details and financial terms, including but not limited to:

Valuation and Structure
- Cash
- Seller note
- Earnout
- Rollover Equity
Asset vs. Stock Purchase
Real Estate
Key Employee Agreements
Non-Compete Terms
Escrow
Any Excluded Assets
Etc.

The letter of intent might also address other topics, such as representations and warranties, indemnification limits, and the indemnification period. While these topics will be negotiated and finalized in the actual asset purchase agreement or stock purchase agreement, it is helpful to have some consensus on major deal points in the letter of intent. This is so that the legal documentation process goes more smoothly.

Binding Vs. Non-Binding Letters of Intent to Purchase a Business

Most LOIs to purchase a business have some provisions that are binding and others that are not. For example, exclusivity and confidentiality are typically binding, meaning that both parties are obligated to fulfill these commitments. Other provisions – such as the target closing date – are usually non-binding.

Fees and Expenses

Most LOIs include a discussion of which parties are responsible for paying transaction fees and expenses. This is particularly relevant in cases where a transaction fails to close for any reason. It is most common for buyers and sellers to each pay their own expenses; however, there are situations where certain parties may agree to cover specific aspects of the deal costs. For example, perhaps the buyer will pay the investment banking fees earned at closing.

Who Signs a Letter of Intent to Purchase a Business?

Both the buyer and the seller, as legal entities, execute the letter of intent to purchase a business. In many cases, especially with smaller private companies, the shareholders of the selling business may also sign as individuals. This is because they may agree to specific key provisions – such as a non-compete agreement – on an individual, personal basis.

What Are Common Pitfalls in a Letter of Intent?

Open-Ended Exclusivity

A LOI must have a termination date that expires at whichever comes earlier: (a) the transaction closing, or (b) a specified date. Failure to include a termination provision can result in a seller being locked in indefinitely.

Vague Key Terms

Key transaction details, such as valuation, the amortization schedule on a seller’s note, or how the earnout is defined and calculated, need to be clearly described and defined in the letter of intent. A letter of intent to buy a business that includes a provision stating “final purchase price will be determined at closing” is problematic.

Summary

A letter of intent to buy a business is a detailed roadmap that ensures all parties are on the same page as they head toward successful due diligence, legal documentation, and closing. It creates structure and trust, while minimizing surprises that could derail a transaction.

At 1719 Partners, we’ve helped business owners navigate this process many times. Whether you are preparing to sell your company or evaluating a potential acquisition, the right LOI sets the tone for the deal.

Thinking About Buying or Selling a Business?

A well-written letter of intent protects your interests and drives your transaction toward a successful close. At 1719 Partners, we have ample experience structuring letters of intent— if you have questions or would like advice on yours, feel free to contact us.

26 August 2025/by Scott Dickes

Finance, Industry Insights

How Much do Brokers Charge to Sell a Business?

Selling your business is one of the most important financial decisions you’ll make. While many owners turn to business brokers for support, before hiring a broker, it is important to understand how brokers work, and how much brokers charge to sell a business. (For a broader look at whether using a broker is right for you, check out our guide to selling a small business.)

What is a Business Broker?

A business broker is a professional intermediary who assists business owners in selling their businesses. They evaluate your business, provide guidance on a selling price, confidentially market the business, and vet prospective buyers. Typically, a business broker helps small and lower-middle market business owners, particularly those with limited time or transactional experience.

The goal of a business broker is to get a deal done, often by packaging the business attractively and creating a competitive bidding process. Not all brokers are created equal, and their value must be weighed against the cost.

How is a Business Broker different from an Investment Banker?

Business brokers and investment bankers both provide advisory and consulting services helping business owners navigate the sale process. While largely semantics, most people would say that investment bankers tend to focus on larger enterprise transactions (i.e. enterprise value in excess of $50 million) while business brokers tend to focus on smaller transactions.

How Much Do Brokers Charge to Sell a Business?

So, how much do brokers charge to sell a business? Business brokers (and investment bankers) typically enter into a formal contract, or engagement letter, with their clients that details a number of factors including compensation. These engagements and compensation structures can vary significantly depending on the scope of the project. For a very limited scope of work, for example preparing an offering memorandum or a valuation, the engagement might be a flat fee. If the service provider is an accountant or an attorney, they might prefer to charge by the hour. Most brokers prefer a success fee arrangement.

Business Broker Fees

Business broker fees can vary significantly depending on the size, type, and complexity of the business sale. Typically, brokers charge a commission, or “success fee,” usually structured as a percentage of the final sale price.

Success Fee: Most brokers charge a success fee between 5% and 15% of the final sale price for small businesses. For larger transactions, brokers often use the Double Lehman Formula or Modern Lehman Scale, which tiers fees by price range. The table below shows a standard (not double) Lehman success fee calculation.

Lehman Commission Structure: example showing $12,500,000 sale price

Retainer or Upfront Fee: Some brokers charge an initial fee ($5,000 to $50,000+) to start the engagement. This covers preparation, marketing, and administrative costs.
Minimum Fee: Even for smaller deals, brokers might require a minimum fee, usually between $25,000 and $50,000, regardless of the sale price.

Who Pays the Business Broker Fee?

The seller almost always pays the business broker’s fee, which is usually deducted directly from the sale proceeds at closing. From the buyer’s perspective, there’s no fee, but buyers know that brokered deals might involve more competitive tension and potentially higher prices because of the structured process. Also, it’s a little like “free shipping”. There is no such thing as free shipping – its cost is just baked into the price.

Can You Negotiate Business Broker Fees?

Yes. Broker fees can often be negotiated, especially the upfront retainer. If your business is highly marketable, you can negotiate a lower percentage or a more favorable tiered structure. Just remember: in many cases, you get what you pay for. A good broker should earn their fee through a higher purchase price or a smoother process.

Alternatives to Using a Business Broker: How Else Can You Find the Right Buyer?

Not all businesses need a broker to find the right buyer. If you have a strong network, a desirable business model, or interest from strategic acquirers, you can sell your business without hiring a broker. If you want to sell your business on your own, here are a few tips to help you gain exposure:

Leverage your personal and industry connections.

Quietly test interest with suppliers, customers, or even competitors.

List the business confidentially on curated M&A platforms.

Reach out directly to investment firms or buyer groups aligned with your industry.

What to Do if a Buyer Reaches Out to You? Should You Hire a Broker at This Point?

Hiring a sell-side advisor in response to an unsolicited offer could facilitate a smooth exit, or it could just muddy the waters, with the pain of paying additional fees. If you like the buyer and if you have a good grasp on your company value, hiring a broker at this point in the process is probably not beneficial. If you have no experience in mergers and acquisitions, and are not comfortable managing the sale process without outside guidance, hiring a professional to help could be beneficial.

For more on the pros and cons of hiring a business broker, check out this blog.

The Buyer You Didn’t Know Existed: The Private Investor Who Has Your Best Interests at Heart

Private equity buyers like 1719 Partners often fly under the radar but offer an attractive alternative to traditional brokers or strategic buyers. We partner with owners of specialized manufacturing, value-added distribution, and industrial services businesses. What makes us different?

We have the capital and experience of private equity, without the sharp elbows.

We prioritize legacy, employees, and long-term success, not quick flips.

We can work directly with owners, streamlining the deal process and eliminating the need for a broker.

Let’s Talk

Interested in seeing if we’re the right fit for you and your business? Want to explore how 1719 Partners can help you accomplish your personal and business goals? We’d be happy to have a conversation. Send us a message.

13 July 2025/by Rich Nicolaides

Finance, Industry Insights

Understanding Debt Covenants

Debt covenants (also referred to as loan covenants) are important components of the legal loan agreement between a borrower and a lender. They exist to protect the lender from risks associated with loaning funds, and to define the terms of the loan agreement so that there is complete clarity between the borrower and the lender. Debt covenants are both affirmative and negative (more on this later) and failure to comply with the covenants can lead to an event of default. Common covenants can include both operational and financial components (more on this later, too.)

Debt covenants are also sometimes called financial covenants.

What is a Debt Covenant?

Broadly speaking, a covenant is a promise made between two parties. In the case of debt covenants, this promise is a legally binding agreement contained in the loan agreement executed by both the borrower and the lender. This occurs when an entity, usually a company, takes out a loan from a financial institution. The purpose of the loan agreement is to protect the lender and to provide guidance to the borrower on expected behavior and company performance.

Affirmative Debt Covenants

Affirmative or Positive covenants are those things the borrower agrees to do. Common affirmative covenants include periodically and timely providing financial statements, maintaining equipment or facility standards, keeping good accounting practices, paying taxes, complying with laws and regulations, etc.

In the debt covenant agreement, affirmative covenants make up their own section. There are often many individual affirmative covenants within a single agreement, and the borrower must abide by all of them. Below are some examples of affirmative debt covenants, from a real agreement.

Affirmative Debt Covenant Examples

Insurance: the borrower must agree to insure all property of an “insurable nature,” including equipment, real estate, and fixtures and inventories. The insurers must be “financially sound and reputable.”
Payment of taxes: the borrower must pay all taxes.
Location of collateral, borrower name and state of organization: the borrower must keep all collateral aside from inventory in transit and motor vehicles at the set forth locations. The borrower should not remove any collateral from said locations except for inventory sold in the normal course of business. The borrower will not change its legal name and trade names without giving the bank 30 days prior written notice. The borrower agrees not to change its state of incorporation or organization.

Negative Debt Covenants

As you may expect, negative debt covenants regulate things the borrower must not do to remain in the loan— or need prior lender approval to do. This can include borrowing more debt, paying dividends, or selling crucial assets. For example, if the borrower were to sell key assets, this could affect company operations— and therefore compromise their ability to repay the lender.

Just like for affirmative debt covenants, there is often a section in the formal agreement for negative covenants. Also like for the affirmative side, there are often many negative covenants within a single agreement. Below are a few examples of negative covenants— from a real agreement.

Negative Debt Covenant Examples

Debt: the borrower will not create debt other than that which is already permitted.
Sale-leasebacks; subsidiaries; new business: the borrower cannot enter into any sale or leaseback transaction with respect to any of its properties or create any subsidiary, or manufacture any goods, render any services or otherwise enter into any business which is not substantially similar to that existing on the Closing Date.
Conflicting agreements: the borrower cannot enter into any agreement that has a term or condition conflicting with this agreement.
Changes in accounting principles; fiscal year: the borrower must not make any changes to its current accounting principles or methods, except the ones required by GAAP. It must also acquire the bank’s consent to change its fiscal year.

Financial Covenants

Within a formal agreement, there is often a third section: that for financial covenants. These can be thought of as affirmative or negative covenants; in other words, if the borrower must maintain a set debt-to-EBITDA ratio, this is both a positive and negative requirement. The borrower must not go above a certain ratio, which is negative, and must maintain a specified ratio, which is positive. Regardless, these covenants are financial in nature.

Since poor financial performance could impair the lender’s loan, the lender and borrower agree to a set of defined financial covenants that the lender uses to verify that the company financial performance is satisfactory. Financial covenants are ratios and calculations that are used to show performance and ability to meet interest and principal payment obligations. Examples of common financial covenants include fixed charge coverage ratio, debt to EBITDA multiple, and interest coverage ratio. We elaborate on these examples below.

Net Debt-to-EBITDA Ratio

This ratio compares a company’s net debt to its cash flow. In this instance, cash flow is measured by EBITDA (earnings before interest, taxes, depreciation, and amortization). You can read more about EBITDA here. Using EBITDA to determine cash flow is a good gauge of a company’s financial health. Comparing cash flow to net debt helps determine the likelihood that a company will be able to repay the debt. It is important to remember that this ratio handles net debt, not just debt; net debt is total debt after subtracting cash and cash equivalents.

So what ratio is a good ratio? This depends on a number of factors, but a general rule of thumb is that a net debt/EBITDA ratio of three or less is considered good, and the lower, the better. On the other hand, ratios higher than this could be a sign of financial stress and lower the company’s likelihood of paying the loan.

Interest Coverage Ratio

The interest coverage ratio is a common financial covenant and can be defined in many ways. One typical definition might be EBIT (earnings before interest and taxes) divided by total interest payments. This ratio offers insight into a company’s ability to pay interest on its debts. This metric also helps determine how risky it is to lend to a company. The interest in this case is interest due to any loan, or line of credit, or other borrowing.

Fixed-Charge Coverage Ratio (FCCR)

This metric assesses a company’s capability to meet all of its financial obligations. These obligations include interest, principal, taxes, and sometimes capital expenditures. Below is the equation for calculating FCCR.

FCCR= (EBITDA + FCBT)/ (FCBT + i)

In this equation, FCBT stands for fixed charges before tax, while EBITDA is a company’s earnings before interest, taxes, depreciation and amortization. The i represents interest. A high ratio signifies an increased likelihood of being able to make payments, while a low ratio shows the opposite.

Below is an example of the FCCR part of a debt covenant from a real agreement.

Default: Breach of Contract

If the borrower does not abide by a covenant, the borrower is in technical default. Some defaults are curable— and others are not. For example, if the borrower is supposed to send the lender monthly financial statements 30 days after month end and forgets to do so, this is a technical default, that is cured once the borrower sends the financials to the lender. In general, there are little d defaults and big D defaults. The example above would be a little d default. A big D default, for example, would be failure to pay interest or principal payments when due. Big D defaults generally trigger the lender to take action. The lender could require an immediate, full loan repayment, end the agreement, or increase collateral or interest rates. The lender may also charge a default interest premium.

In Summary

Debt covenants play an important role in leveraged finance. Banks feel comfortable lending to companies because they have certain rights and protections provided in the credit agreement— including covenants. Borrowers are willing to give up certain rights and abide by the restrictions in return for access to the lender’s capital.

If you have any questions about debt covenants, send us a message— we would be happy to help.

6 May 2025/by Scott Dickes

Finance, Industry Insights

The Power of Long-term Holds

We have mentioned that long-term investments generate superior returns, but just how much higher are these returns? This is what we wanted to find out, so we created a simple model which shows that long-term investment returns are significantly higher when compared to a standard private equity hold.

Read on to understand our methodology.

The Assumptions

First we had to set timelines for both the long-term hold and the standard hold periods. We set the true long-term hold timeline at 25 years and the standard hold at 5 years. Investors would pay a federal capital gains tax of 20% at the exit. We also set the state capital gains tax at 6%, although current state capital gains tax rates vary from 0 to 14.4%.

For the traditional exit strategy, we set a timeline of 5 years per investment. While hold periods can vary, this is a pretty typical private equity investment horizon. For the shorter hold period, the investor has the same capital gains tax rates as for the longer period. To make the hold periods most comparable, we made the original investment and annual rate of return the same for each: $1 million and 12%.

While the long hold had one investment for the 25 year period, the shorter strategy made five different investments in the same time period. This way, both strategies remained fully invested for the same amount of time.

The table below summarizes the assumptions.

The Results

The only difference between the two scenarios were the hold times. But, due to this difference, the traditional exit strategy paid capital gains taxes five separate times vs. only paying one time for the longer hold period. Each time taxes were paid, the net after-tax proceeds were reinvested. Losing the benefit of compounding returns from the amount paid in taxes, over time, significantly reduced the total gain for the shorter term strategy. The traditional strategy’s net after tax gain was $9.5 million vs. $12.9 million for the long-term strategy. Despite paying $1.1 million more in total taxes, the long-term strategy generated about $3.5 million additional long-term after-tax proceeds. This is truly a dramatic outcome which highlights and reiterates the financial benefit of long-term holds.

Caveats and Other Considerations

Obviously we don’t live in a perfect world and annual rates of return, tax rates, etc. will all vary over time. Changing the rate of return has a significant impact on the outcomes. Higher rates of return amplify the results and lower rates of return reduce the difference between the two models. For illustrative purposes, Increasing the annual rate of return to 15% from 12% generates an additional $5 million of after-tax proceeds for the long-term hold strategy!

This scenario simply looks at the numbers. It assumes the longer investment time period changes nothing but the hold duration. However, in practice, there are other ideas to consider: For example you may want to sell earlier if your investment is not generating the desired rates of return and you think you can redeploy the investment into a higher return asset. Or perhaps capital gains taxes are eliminated or greatly reduced in the future which makes selling and reinvesting less expensive.

See the tables below for a closer look.

If you have any questions about this model or are curious about other benefits of a long-term hold, please contact us.

12 April 2025/by Scott Dickes

Finance, Industry Insights

Private Equity vs Venture Capital

At the first glance, private equity and venture capital appear quite similar. Indeed, they have comparable structures: in both, firms invest in private companies with plans of selling down the road and making a profit. If you own a company and are considering how outside investors could help you, understanding private equity vs venture capital is relevant.

Private Equity vs Venture Capital: the Similarities

Both venture capital and private equity firms operate in the private market. That means they either invest in privately held companies or, in certain rare cases, invest in a public company and take it private.

In addition, both types of firms operate with a Limited Partner (LP) framework. In order to raise capital to invest in companies, the firms work with high net worth individuals, institutional investors, or foundations. These investors, called Limited Partners, agree to provide a certain amount of capital, or “committed capital”, for the investment.

Both venture capital and private equity firms charge their LPs a management fee: typically 1.5-2% of the applicable assets. They also charge carried interest: around 20% of the investments’ profits once the minimum return is met.

And, as stated earlier, the firms have the similar end goal of selling the company at a higher price in the future, thus capitalizing on the investment.

Venture Capital Firms

Venture capital firms differ from private equity firms in a few key ways.

Company Types

One primary way is the type of companies venture capital firms typically invest in. These firms focus on early-stage companies they deem have a high potential for growth. However, there is a catch: just as these companies with an uncertain future could result in a big success, they might fail. So, while the payoff could be higher than private equity investments, the risk is also higher. Common industries for venture capital firms to invest in are technology, information technology, and biotechnology.

Investment Size

Venture capital firms typically make smaller investments than private equity firms: the initial investment is usually between $1 and $10 million. This is because venture capital firms often concentrate on younger companies that are in the earlier stages of business. However, as some successful venture backed companies grow, the additional funding rounds can become very meaningful and raise hundreds of millions of dollars.

Investment Structure

Venture capital firms frequently acquire a minority stake in the company. In other words, they make up less than 50% of ownership. This stake is usually funded with cash, in return for purchased equity, and venture backed firms rarely use debt because these early stage companies need cash to grow, and are often unable to amortize funded debt.

Private Equity Firms

As you may expect, private equity firms are different from venture capital firms in a few notable ways.

Company Types

Unlike venture capital, private equity firms invest in mature companies. Depending on the firm, these companies can vary widely in size— from $5 million to billions of dollars. While these established companies are a lower risk investment than the younger companies of venture capital, they can still need guidance to grow. For example, the company may be operating inefficiently or may need equipment updates.

In contrast to venture capital, private equity firms focus on a wider range of industries and make more conservative investments. Thus, the potential for very large investment returns is lower than for venture capital— but so is the chance of business failure.

Investment Structure

Unlike venture capital, private equity firms typically use a combination of debt and equity. Mezzanine debt, senior debt, and seller notes are frequently used as leverage. This is because, unlike with startup companies, these developed companies are able to pay back debt from ongoing business operations.

Private equity firms also usually acquire a majority stake in the company, or over 50%.

Beyond Private Equity vs Venture Capital

There are some investment firms that do not fit a definition. One such firm is 1719 Partners. 1719 Partners has some common ground with private equity: we aim to grow small businesses, we have the transaction experience necessary to close deals, and we have established financing connections.

But we are unlike standard private equity firms in that we do not invest in companies just to profit from the later sale. Our focus is on our companies’ long term success, and we realize this looks different for each different business. Our mission is to always do what is best for the company, and this means investing thoughtfully and patiently. For this reason, we have no predetermined sell date. In other words, we buy to hold. If you have questions on the pros and cons of private equity, or are curious about 1719 Partners’ mission, please contact us.

25 March 2025/by Scott Dickes

Finance, Industry Insights

Enterprise Value vs Equity Value

Understanding enterprise value vs. equity value helps in interpreting business valuations. While both metrics give insight into the value of a business, they differ in a key way: enterprise value denotes the entire value of a business without considering its capital structure, and equity value describes the value that belongs to shareholders.

This post will dive into enterprise and equity values, and how each is applied.

Enterprise Value vs Equity Value: A Simple Analogy

Looking at real estate financing provides a useful analogy for comparing enterprise value vs equity value. The total value of the house, or its enterprise value, does not depend on the property’s mortgage size. Let us use this example below:

House A:
Total price of house: $750,000
Mortgage size: $300,000

House B:
Total price of house: $750,000
Mortgage size: $200,000

In this example, both houses have the same enterprise value. If both owners were to sell, the homes would in theory sell for the same price. But the previous owners of house A would receive $450,000 in equity value, whereas the owners of house B would receive $550,000 in equity value. This example illuminates how equity value depends on capital structure, whereas enterprise value does not.

Enterprise Value

To understand the difference between enterprise value (EV) and equity value, let us first describe EV. Simply put, enterprise value is what a third party would pay for the business in question. The metric does not reflect the company’s capital structure— in other words, its combination of debt and equity financing. Different companies often have different capital structures; while one company may be funded with more equity— or even have no debt at all— another may have relatively more debt.

Using EV can be useful for comparing companies of differing capital structures. Because it does not take capital structure into account, it provides an equal playing field of sorts to compare companies’ market values.

Types of Debt

There are multiple kinds of debt that can make up the debt portion of a company’s capital structure. Among these are senior debt, seller notes, and mezzanine debt. While these forms of debt differ, they are all considered debt and not equity.

Enterprise Value Formula

The formula to calculate enterprise value (EV) is below.

EV= Equity Value – Cash + Debt

Debt and equity value are added together because debt and equity make up a company’s overall capital structure. Cash is subtracted because the company’s cash and cash equivalents will be inherited by the buyers in an acquisition, reducing the total cost of the acquisition.

Equity Value

Equity value is the value of the business that belongs to shareholders after subtracting debt and other liabilities. Equity value is useful for determining how much shareholders of a selling company will receive from the acquisition. Debt is subtracted from the formula because debts must be paid off before the sellers can pocket the proceeds. Cash is added because this liquid asset belongs to the shareholders.

Equity Value Formula

The formula for equity value is below:

Equity Value= Enterprise Value (EV) – Debt + Cash

Enterprise Multiple

You may have also heard of the enterprise multiple, or the EV/EBITDA ratio. Another word for the enterprise multiple is the EBITDA multiple. You can read more about EBITDA multiples and company valuations here. Essentially, the enterprise multiple is equivalent to a company’s enterprise value (EV) divided by its EBITDA. In an equation, this looks like:

Enterprise Multiple= (Enterprise Value)/EBITDA

In Summary

Enterprise value and equity value are both useful in determining a company’s worth. However, enterprise value is more helpful than looking at only equity value for analyzing the bigger picture of a company’s value, as it takes debt into account.

Understanding your company’s enterprise value is a smart first step if you are considering selling. If you would like to discuss what your company’s enterprise value might be, please contact us. We would love to learn more about your company and discuss how we may be able to work together.

8 March 2025/by Scott Dickes

Finance, Industry Insights

Borrowing Base: How it Works

An asset based working capital line of credit— or revolver— provided by a lender typically incorporates a provision called a “borrowing base”. A borrowing base is a calculated dollar value that sets the upper limit on how much money the company can borrow from its lender on the line of credit. This borrowed working capital is used to fund ongoing business operations, such as purchasing inventory needed for later sales, or to finance accounts receivable. Understanding how a borrowing base works is important for understanding how high your working capital line of credit could be. We also discuss how a working line of credit may be used in acquisitions.

What is a Borrowing Base?

A borrowing base, in simple terms, defines how much money an asset based lender is willing to loan a company. The borrowing base is calculated based on the value of the company’s assets used as collateral. However, determining the collateral value of those assets is not as simple as taking the book value. A portion of the assets may be excluded, and the lender also applies a discount factor, known as an advance rate. We will detail how to calculate a borrowing base in this post.

Collateral Types

Different types of assets can be used as collateral, such as accounts receivable, inventory, or equipment. Larger assets such as property are typically not used as collateral for a working capital line of credit. Such assets are more fitting for long term debt, like a house in a mortgage for example. In general, assets that hold value over an extended period of time— and decline in value predictably— are paired with long term debt, while assets with temporary value are paired with short term debt.

Borrowing Base Calculation

The borrowing base calculation begins with the book value of accounts receivable and inventory. Next, certain ineligible assets (as defined in the credit agreement) are removed. Finally, the value of remaining eligible assets is then multiplied by the advance rate, or the portion of the assets the lender is willing to lend against. The advance rate for accounts receivable is typically 80%, and the advance rate for inventory is usually 50%. Then these two separate values are added together to determine the borrowing base amount.

For example, if a company’s eligible accounts receivable balance is $1.6 million, then calculating the accounts receivable portion of the borrowing base looks like this:

1,600,000 x .8= 1,280,000

And if the value of the company’s eligible inventory is $1.0 million, then calculating that portion of the borrowing base looks like this:

1,000,000 x .5= 500,000

To calculate the final borrowing base value, both portions are added together:

1,280,000 + 500,000 = 1,780,000

In this situation, the company’s borrowing base would be $1,780,000. The question then becomes, what assets are ineligible?

Ineligible Accounts

Unless deemed ineligible, the borrowing base calculation includes all inventory and accounts receivable. Generally, ineligible accounts are ones the lender views as risks on the ability of the borrower to convert to cash.

Old Accounts Receivable

When a company sells with credit, it is normal for invoices to take some time to get paid. While due in 30 days is common, some accounts receivable can creep into the 60-90 day range. When an account ages past 90 days, it can signal distress on the customer and indicate uncertainty that the customer will pay the balance.

While it depends on the lender’s risk tolerance, most lenders will remove the entire account associated with the late payment. So if a customer has not paid a balance in 90 days, the full account associated with that customer would be removed from the borrowing base.

Customer Concentration

The more diverse group of buyers a company has, the less harmful it will be if one customer stops doing business with the company. As soon as a sizable amount of business is concentrated to one or a select few customers, the lender will be wary. This is because if a large customer fails to pay, the company’s accounts receivable balance will drop significantly, and the lender may have advanced funds based on this collateral. Now the lender will be in an over-advanced position and might require the borrower to immediately reduce the outstanding balance on the line of credit to bring it back in compliance with the borrowing base.

To reduce exposure to this risk, banks will often set a customer concentration limit, say at 25%. If a customer makes up 40% of the company’s accounts receivable, for example, 15% of the balance would be removed from the borrowing base.

Unsellable Inventory

As inventory value makes up some of the borrowing base, the ability for the inventory to be sold must be monitored. Sometimes inventory proves to be obsolete, excessive, or otherwise unsellable, while the company could still be including this inventory’s value on its balance sheet. For the inventory balance to be accurate, the company would need to remove the value of the unsellable inventory.

To mitigate this risk, the lender may conduct site visits— to the company’s warehouse for example. This is to ensure undesirable inventory is not piling up somewhere. In addition to site visits, lenders will watch for trends in inventory sales. For example, if inventory’s time in the warehouse is typically short-lived but becomes much longer, the lender may start asking questions.

One strategy to protect against future obsolescence is the use of inventory caps. Inventory caps are based on past sale trends: if a company typically only sells a certain portion of its inventory while the rest ages out, the value of the aged out portion would not be included in the borrowing base. The inventory cap is an estimate based on projected future performance. For example, the bank may exclude inventory that is in excess of one year sales. As a result, the portion of included inventory could be very different from the company’s inventory book value.

Government Accounts

Any balances associated with the Federal government are typically not included in the borrowing base. This is because the company cannot sue the government for any outstanding balances.

Borrowing Base Certificate

Over time, a company’s borrowing base must be monitored. A borrowing base certificate is a formal document that governs how the borrowing base will be re-calculated over time. In other words, it sets the terms for the loan and the amount that can be advanced. Because a company’s inventory and accounts receivable fluctuate often, the borrowing base may need to be calculated often.

For the lender to monitor the borrowing base, the borrower is required to supply an accounts receivable and inventory record at regular intervals. Such monitoring ensures the lender is only advancing what can be backed by its assets.

Borrowing Base and Acquisitions

Can a working capital line of credit be used to finance an acquisition? A line of credit is typically not an appropriate financing source for acquisitions. As discussed earlier in this post, larger assets with predictable long-term value are better suited as collateral for longer term loans. Thus, term debt should make up a large portion of an acquisition, for example 50%. If a working capital line of credit is used to finance an acquisition, it is typically a very small portion— like five to ten percent of the total sources of funds.

1719 and Acquisitions

When 1719 Partners completes an acquisition, we always have a working capital line of credit to ensure business operations can continue as usual. We recognize that this is necessary to fund a business’s liquidity needs. As mentioned above, 1719 does not rely on a line of credit to finance an acquisition; most of the financing is supplied by term debt and our equity investment.

If you have any questions on how a borrowing base works, or about using a working line of credit in acquisitions, we would be happy to help. Simply contact us and we will be in touch.

13 January 2025/by Scott Dickes