How equity gets divided in an ETA deal determines your upside at exit more than almost any other negotiation in the process. Most searchers spend months on the business acquisition and far too little time understanding the cap table they are building. Here is the full mechanics — for both traditional search funds and self-funded structures.
Traditional Search Fund Cap Table
In a traditional search fund, the searcher raises two tranches of capital: search capital (typically $400K–$600K to fund the search phase) and acquisition capital (raised deal-by-deal at close). Search capital investors receive preferred equity with a right of first refusal to invest in the acquisition.
At close, the Stanford GSB 2024 Search Fund Study (which covers 562 funds globally) reports the following median equity split: investors hold approximately 70–80% of equity (preferred, with a preferred return), and the searcher holds approximately 20–30% as carried interest — formally called the "founder's equity" or "promoted interest." The median in the 2024 study is 25% for the searcher.
The searcher's 25% is not free. It typically vests over 4–5 years with a one-year cliff, and it is subordinate to investor preferred equity until the preferred return hurdle is cleared. In a European waterfall structure, investors receive their full return multiple (often 1.5x–2x of invested capital) before the searcher participates in carry. In an American waterfall, distributions are shared proportionally on a deal-by-deal basis.
Self-Funded Search Cap Table
In a self-funded search, the searcher uses personal capital (savings, 401K rollover, home equity) plus SBA financing to acquire the business, sometimes supplemented by one or a small number of equity investors. The equity structure is fundamentally different: the searcher typically enters with 30–60% equity at close, with investors (if any) taking the remainder.
The tradeoff is financing risk and deal size. Self-funded searchers are constrained to businesses they can finance with SBA 7(a) loans (which currently max at $5M for business acquisitions) plus their equity contribution. They enter with more equity but face more personal financial risk and a narrower deal universe.
What Dilution Looks Like in Practice
Assume a traditional searcher raises $500K in search capital from 10 investors, who each receive a right to invest in the acquisition. The business closes at $4M enterprise value. The investors exercise their rights and invest $2M of equity (with $2M in SBA debt). The cap table immediately post-close: investors hold 75% preferred equity (their $2M at the agreed valuation), and the searcher holds 25% promoted interest.
If the business sells for $8M five years later (2x return on enterprise value), and investors have a 1.5x preferred return on their $2M ($3M total before carry): the first $3M of proceeds goes to investors to clear their preference. The remaining $5M is split 75% investors / 25% searcher — meaning investors receive $3.75M additional, and the searcher receives $1.25M. Total: investors receive $6.75M, searcher receives $1.25M on a $8M exit.
Equity Negotiation Points That Matter
Four terms deserve serious negotiation: the preferred return multiple (1.0x–2.0x is standard; anything above 1.5x materially compresses your carry), the waterfall structure (European vs. American, and whether catch-up provisions exist), vesting schedule (cliff and vesting timeline), and the definition of the cap table at closing (what happens if the deal is re-traded and equity is raised at a different valuation than anticipated).
The 2024 Stanford study found that searchers who negotiated their initial terms clearly at the search capital raise — rather than leaving them to be "resolved at close" — achieved outcomes 8–12 percentage points better on carry economics at exit. Get a search fund attorney (not a general M&A attorney) to review your PPM and equity documents before you sign.
Management Equity and Key Employee Plans
Post-close, some searchers carve out 5–10% for a management equity or option pool to retain and incentivize key employees. This comes out of the searcher's equity, not investors'. Budget for it. The businesses most at risk in an ownership transition are those where the seller took all key relationships and knowledge with them — an equity pool for key managers is one of the cheapest transition risk mitigations available.