Can You Buy 100% of a Business with Other People’s Money?

Summary

In this conversation, Jon Stoddard interviews John Panaccione, a veteran and entrepreneur who co-founded Logic Bay and later launched Fola Capital. They discuss the intricacies of participating preferred equity, the challenges of raising capital for small to medium-sized business acquisitions, and the evolving landscape of SBA loans. John shares insights on structuring deals, investor relations, and the importance of understanding the rules surrounding capital raising. The discussion highlights the opportunities available for buyers looking to acquire businesses without significant upfront capital.

Takeaways

• Participating preferred equity provides investors with a preferred position and additional rights.
• Crowdfunding emerged as a viable option for raising capital in 2012.
• SBA loans can be complemented with seller financing and investor contributions.
• Understanding SBA rules is crucial for structuring deals effectively.
• Reverse engineering valuations can help buyers negotiate better prices.
• Investors need to have a clear understanding of the terms before committing.
• Raising capital requires building relationships and trust with potential investors.
• The process of acquiring a business can be more straightforward than starting a new venture.
• Veterans often face unique challenges in accessing capital for business acquisitions.
  Folla Capital offers a structured approach to help buyers navigate the acquisition process.

Listen to the Episode Here:

 or Watch the Episode Here:

Transcript

Jon Stoddard (00:00.981)
Welcome to Top &A Entrepreneurs. Today, my guest is John Panaccione, a fellow veteran, army officer. He co-founded a company called Logic Bay. It's a partner CRM software system. And then he sold that to a PE firm investor. And he's got some interesting takes on what participating preferred is. And then he launched Fola Capital. You can see it on his shirt. It is a registered SE broker dealer.

with the ability to raise money. And we're here to talk about how he can help SMB buyers raise a hundred percent of the money, no money out of your, the buyer's pocket to buy a business. So welcome to the show, John.

John Panaccione (00:44.866)
John, great to be here and privileged to be here. So thanks for having

Jon Stoddard (00:48.663)
Yeah. So we got to go back. You and I have talked a long time about this logic bay and this participating preferred and your take on it or your definition of participating preferred. From my audience, I need them to hear what your definition is.

John Panaccione (01:07.136)
Generally speaking, it's a set of rights for equity investors so that they kind of have a preferred position at first, which usually accrues a dividend and they're first in the order to get paid upon liquidation. And then a participating preferred is that plus after they've been paid their accrued dividend and paid first, they participate in what's left at some percentage ownership.

that they bought when they invested the first time. So it's a great deal for equity investors, but a lot of us, when we first started out, me included, don't know what we're getting into. Sometimes when we get into the details of those types of deals and other rights, those investors tend to have in addition to that, that we learned the hard way.

Jon Stoddard (01:52.311)
step up, coupons, all kinds of stuff, liquidation rights. Yeah. Yeah. All right. So, yeah. I do have to ask you a question. I didn't ask you why after starting this company, why did you start a broker dealer company?

John Panaccione (01:59.918)
put options, call options, all that stuff.

John Panaccione (02:12.43)
Long story short, we were a software company, as you said. So we were in the B2B space and I needed to raise money. So like many companies, and I owned the company for 17 years before we sold it. So during that 17 years, we always had working capital challenges, growth capital challenges. I pulled every rabbit out of every hat that I could find. And one of the rabbits was coming along in 2012 called crowdfunding.

And I was watching that in 2010, 2012. So when it got passed as part of the jobs act here in North Carolina, they had a state program and I went, I was going to use it to raise capital for logic bay. And that's how I got kind of up to speed on the basics of it. And then I went to the secretary of state's office one day for a meeting on as soon as the state passed their program.

And I sat around this big table in the secretary of state's office. said, I want to raise money. She goes, well, you'll be the first one. I'm like, great. And they say, what, we got good news and bad news. said, what's the good news? So what you can raise money now. I'm like, great. What could possibly be the bad news? And they said, well, you have to use a state approved software platform and we don't have one yet. I'm like two hour drive back from Raleigh. realized we were a software company. Long story short, we ended up being these.

the first and I believe only software platform that was approved for crowdfunding. So we started to do crowdfunding for some North Carolina companies. That's how I got into it. I sold that company Logic Bay. And one thing I asked not to be involved in the sale was this piece of the software. And that's how that's what kind of rolled in the full account.

Jon Stoddard (03:51.863)
Yeah, that was a completely different interest, which you could easily separate. Yeah. So let's talk about this new offer. The reason you and I keep talking is because I, you know, I, like to help people buy their first business. And one of the biggest challenges raising the money, whether it's the down payment and, the bulk of it, which being a seven SBA, seven a loan. but specifically, if you're finding a great business, HVAC as an example.

John Panaccione (03:56.61)
Right. Yeah.

Jon Stoddard (04:21.517)
you know, it's a $3 million business and they're asking for 10%. A lot of people don't have $300,000, whether it's equity in the house, HELOC or, or sitting in their IRA. So that's why we're here talking about this new program you got. And look, I understand this is kind of proprietary, so keep it, you know, what we can do and the specific of who you're looking for to help.

John Panaccione (04:47.714)
Yeah, so in a nutshell, it's probably the topic you've discussed on this podcast. There's always some changes being made every couple of years with the SBA rules. So the more recent ones allowed for some portion of seller financing to be part of that equity portion. So that's part of the solution. The other part of the solution is to now you can bring in investors to fund whatever's left of that 10%. It doesn't have to come from you personally as the borrower.

Jon Stoddard (05:05.346)
Yeah.

John Panaccione (05:17.518)
So it's really those two tools combined that create a strategy where that 10 % can be filled by other people's money, whether it's the seller or investors. Sure.

Jon Stoddard (05:27.245)
Yeah, let me ask you a question. I'm sorry to interrupt you, but what are your thoughts on seller financing, keeping somebody in the business 19 % so they don't have to sign a personal guarantee versus finding outside equity investors?

John Panaccione (05:42.062)
Look, I tell everybody read the SBA rules. They're online. Just read them. one of the things seller financing is part of that deal that I just described. Sounds good. But when the sellers actually see what's what they can do and what the restrictions are on getting paid, they usually say thanks, but no thanks. And part of that is they can only do interest if that for two years and then it can't be any balloon payments. you know,

The lender that provides the SBA loans got to be paid first. So when all of that is understood, the seller usually goes, I'm not sure I want to do that. What I'd suggest people do is don't buy 100 % of the company. know, buy 90 or I got one deal right now where we're doing this. We're going to buy 90 % of the company. The owner retains 10 % and you can almost pay that off like a seller note. But because it's not debt, it doesn't.

It's not treated under the rules the same way that I just described. So I don't want to get in the weeds on that, but, you know, there's a ways to deal with seller financing as part of the solution.

Jon Stoddard (06:48.535)
So how are you using your Fola capital to help somebody raise the down payment to do this? you know, this is a, got to, the reason I'm bringing this to the forefront is just that, you know, this is a completely new asset class. Like going out to investors, go, I need help to, you know, from a main street investor to raise the down payment to purchase a, you know,

Main Street Business.

John Panaccione (07:20.514)
Yeah, so we're a broker dealer. our, you know, our core business is raising capital under several different SEC exemptions, more commonly known as reg D's. And there's several types of those and reg CF, which is crowdfunding. And technically we can do reg A's, but we haven't done any of those yet. So mostly reg D and reg CF exempt offerings are, you know, you have to follow the rules. And again, these are online too. You can go to the SEC and read about them, but,

because we're registered with the SEC, we can actually facilitate these capital raises. So kind of our secret sauce is we can actually exercise what I just said as a broker dealer and help our clients raise capital during the due diligence phase on a path to buying a company and actually sometimes raise a lot more than 10%, by the way. So you're actually financing less. And the terms of those, that capital can be

all kinds of things, but we usually tailor the terms of that capital to behave nicely with an SBA loan, and I won't get into the details on that. So the bottom line is we can raise capital because we're a broker dealer, and we've templatized a lot of what you need to raise capital under the rules, like an operating agreement, for example. We can talk about that. So when we have somebody on a path to trying to close and close within 90 days,

We've got a templatized approach to help that person raise capital legally to get the deal done.

Jon Stoddard (08:52.753)
I'm going to go into that process and what that looks like if I was to come to you first meeting and what happens, what happens, what happens next. But I want to ask you about, I have somebody in my network that just decided to go, I'm going to go raise capital. And he started putting out ads on Facebook and saying, Hey, raise, you know, I want to, you know, come in. You can be an investor. We're going to get a, you know, 50 % return, blah, blah, blah. How bad is that to the SEC?

You

John Panaccione (09:23.41)
That's really bad. know what the guy's doing, he's selling a security and you know, he's not in a position to do that. So he's either got to go to a securities attorney or a law firm that because of their regulations that govern law firms, know, a securities attorney can help him raise money, but a broker dealer can't too. And that person definitely needs to go with one of those. He's wasting his time. Even if he raises the money.

Jon Stoddard (09:28.609)
Yeah.

John Panaccione (09:49.726)
Once somebody figures that out, he'll have to return the money. And if he's already bought the company with that money, he's in big trouble. But I'm not to scare everybody, because I hate when people talk on these things that scare everybody.

Jon Stoddard (10:00.715)
No, but you can't, it's not like you could just go, I need to go raise money and put ads on, Facebook if Facebook allows you, but there's ways to say that. So he needs to go through the entire process, file a reg D, and then have an attorney, SEC attorney with a private placement memorandum subscription agreement and everything else in place before he starts.

raising, taking any money from anybody.

John Panaccione (10:23.852)
Yeah.

In short, yes, but let me offer some clarification which might be helpful for some people.

When you don't really file a PPM, you actually only file a PPM once you're successfully raised and have done an initial closing, then you file with the SEC. With Reg CF, it's different. You have to file what's called a form C before you raise money. So it depends on which of the exemptions you're using to raise a capital. You can use each, by the way. We can't use Reg CF, but anyway.

Let me just split Reg D down into two different kinds of Reg Ds. There's a Reg D 506B and a Reg D 506C. And there's big differences between the two. One of them is a 506B. You can involve or have up to 35 non-accredited investors, which is 89 % of the population. With a Reg D 506C, you have to have 100 % accredited.

That's one big difference. The other big difference is with a reg D five six B you cannot advertise. You have to have a preexisting relationship with the investors with a wreck.

Jon Stoddard (11:37.709)
Can that, let me get, jump in here. Can that existing relationship actually be a first connection on LinkedIn? Not actually ever talking, but can that qualify?

John Panaccione (11:51.704)
You know, there's all these gray areas. Technically, it could qualify, depends on, you know, is that connection on LinkedIn somebody you've done business with or a relative, you know, or is it just a complete stranger that LinkedIn with you? There are degrees of links with LinkedIn, but that's a good question. I get it all the time. It is a gray area, judgments required, but theoretically it's friends and family.

and people you have some kind of relationship with. You have their email address, you've done business with them or their friends and family, right? So lots of the deals I do are 506Bs because what you want to do is raise the money quickly because you only got a certain window of time. You got to close the deal, right? So a lot of times you're going to go to people you know, total strangers. It's really tough to get a total stranger to act very quickly to get your deal done. They don't know you. They don't know the business you're buying.

With what we do a 506 B is usually what we use because you got to go fast and there's a lot of people need to know you. Now I'm not saying now the 506 C you could do a Super Bowl ad if you wanted to you can advertise the heck out of it. We do 506 C's but usually that takes long.

Jon Stoddard (13:03.703)
Yeah. All right. So let's go to the part where you describe, you know, actually what it looks like when I first walk into you. I, what the avatar looks like. I've got to have a deal under LOI. I need a credit score of something, a 640 or better. Do I already need to be proved for SBA or the deal does? What does that look like if I'm coming to you and I go, John.

I got a deal and I need help raising $300,000 to buy a 3 million company.

John Panaccione (13:37.688)
Well, good question. mean, we usually deal with folks that aren't qualified for SBA and all that. And that's a whole other conversation. But, you know, the wording of the rules around SBA, it says specifically in the rules for SBA that the SBA loans exist for people that cannot qualify for conventional financing. So this whole notion of you got to get pre-approved with SBA.

It's kind of an oxymoron, right? The whole purpose of the SBA is to help us poor souls that don't have a lot of money that want to buy something. The government's going to back us, right? If we have some other criteria. So that aside, most of our clients, you know, they don't have a lot of cash in the bank. As you said, I deal with a lot of veterans, for example, you know, some dude just retires at 40 years old, served this country for 20 years. He doesn't have millions of dollars in the bank, but he's he or she's a great person, right? Great America.

Jon Stoddard (14:05.303)
Yeah, yeah.

John Panaccione (14:32.78)
So that's typically who we work with. It doesn't have to be that, but come to us. We're usually pre LOI. We like to get involved early through an affiliated company full of consulting services. have a buy side advisory service. We charge a small monthly retainer and we help searchers kind of, we coach them along the process of finding a company and then we help them with their LOI. You know, it's part of what we do. And then we,

then we help them through due diligence. And then in that phase is when we're pulling and full of capital to potentially do the capital raise, because that's a regulated activity. And then that whole process kind of is a package that we all.

Jon Stoddard (15:15.095)
Yeah. So let's, let's talk about like specifics. It's gotta be a good deal. cash flowing debt service coverage ratio, during the problem with five, 10 years old, what does that gotta look like?

John Panaccione (15:27.842)
You know, it can look like anything. What we do is reverse engineer the deal. And I don't know why more people don't talk about this. So, you know, the standard is, you know, my valuation is X, right? That's what the seller says. You know, our advice to buyers is early in the process, doesn't matter what X is. What you want to do is get an LOI sign. It's non-binding. And then what we do is reverse engineer the price. So what we do is we model the business in a typical modeling

spreadsheet, right? And what we want to do is determine, given the purchase price and the carve outs and the ad backs, go through that exercise, what is the debt service coverage ratio that we're going to take to the bank? And if it's too low, the price is too high. If it's in a zone with some margin above 1.15, which is the SBA hurdles, some banks have higher hurdles, well, let's just use 1.15. If it's way above that,

We know that it's a reasonable price. So that's a big check that we do. And then that exercise serves as well when we go into due diligence and kind of prove our assumptions about that model. So that's kind of our process. There's been a number of times we've emailed that same analysis back to the seller and said, you're way out of whack, dude. But here's what we're willing to buy. You can't argue with reasoning. They're looking at their own numbers.

Jon Stoddard (16:53.174)
Yeah.

John Panaccione (16:54.05)
I'll get into it, but that's kind of our process.

Jon Stoddard (16:56.937)
Is there any businesses in the buy box or outside the buy box? It's not going to do like, you know, if it's a hundred percent, service-based business, key man risk or industries like, you know, gun sales, second amendment or e-commerce.

John Panaccione (17:14.21)
No, I live in North Carolina and I'm a veteran, so I'm a fan of guns. no, and you kind of touched the nerve there because when I was running a company, I got tired of gatekeepers, you know, and there's a lot of gatekeepers in this world and we don't want to be a gatekeeper. We think the public should decide who the winners and losers are. So we like to say we facilitate a process. We don't really say no to anybody.

Jon Stoddard (17:19.627)
Okay.

John Panaccione (17:42.408)
or any kind of idea. That's not our role to judge people or their ideas. So we facilitate a process and let let, you know, the public decide whether it's successful or not. So we feel pretty strongly.

Jon Stoddard (17:54.029)
Yeah. So you get a deal guy comes in and he needs $300,000 and he's not approved for the SBA loan yet. You're going to help package this deal together. And then when you go out for $300,000 to your network, what, what, what does those terms look like to the investor? What are you looking for? it back to the, you know,

participating preferred? Is it rev share? Is it common? Is it, what is it? And you don't have to get too specific to give away the deals, but I'm just curious what that looks like.

John Panaccione (18:31.064)
Yeah, good question.

John Panaccione (18:35.18)
Yeah, we do have one little secret thing in our operating agreement that we've come up with, but I'll just kind of beat around the bush. within the rules, we actually worked on this with a couple of very large banks, because we have referral agreements with a few banks. It's another thing we do for our clients. We already have established banking relationships. So we take that exercise with the Excel file I just told you about.

That's actually what we send to our bank when we do a referral. So we want to do this deal. So we already do a lot of their underwriting form. But anyway, back to your question, we have a standard operating agreement that we've developed and within it, there are certain classes of units. Let's just say it's an LLC. There's different classes of LLC units. So our client would have one class, say class A, those are voting units.

Jon Stoddard (19:01.399)
Yeah.

John Panaccione (19:27.912)
and all that, right? Then a second class would be for the investors, call them class B units. And they're non-voting, but they have certain unique rights. And those unique rights is what I'd rather not get into publicly, but they're pretty cool options for the investor. Basically, gives them a right to sell back their investment to the company at some certain point in the future.

which provides liquidity for investors, they don't have to wait for you to sell the company, right? That's the big bonus. So then, then those rights are defined in the operating agreement that they could convert to another series of units later on at the discretion of the investor. And I'm going to stop there, but basically the operating agreement has this canned set of rights for the investor. And that's what we kind of try to sell to the investors. Like, look, if you invest in my deal, here's how it starts out.

At this point, you can make a decision, whatever you want to do. You can stay in the deal or you can get out. And that's the deal kind of, and it's all written up in this operating.

Jon Stoddard (20:31.467)
Yeah. Earlier said you looking for pre LOI and sometimes these guys, buyers go to the business and they don't have, you know, they don't have a net worth of 5 million bucks though. So they need proof of funds. Do you help with that? Nope.

John Panaccione (20:47.586)
Nope, you know, we just assume you broke and

Jon Stoddard (20:52.395)
Well, I mean, to proof of funds to the broker selling the business. they go, well, dude, I don't see you having a business. How are you going to raise that money?

John Panaccione (21:01.464)
Well, John, you know, we do everything off the beaten path. So to a broker that demands that we say, you know, show me any rule that said that's what says that's a requirement. There is no such requirement. It's what every broker does, though. And because a lot of brokers come from the real estate world where they were selling houses. Now they're selling businesses. And that's what you do when you try to sell a house. There is no rule that says brokers have to ask you that question. Most of our clients, particularly veterans, they don't have the net worth to go get a

pre-approval loan that you're looking for. So let's just put the kibosh on that is what I tell brokers that I deal with successfully too, by the way. And I don't mean to be a bully, but there is no rule that says that. Now, when I describe what we can do to get my client funded, then they tend to say, okay, well, I don't need the pre-approval then, right? So two things. One, first is what I've learned is pre-approvals are just ways that banks isolate you and...

get you committed to give them the deal first, in my opinion, right? It doesn't mean anything. There are like seven approvals that you have to go through with a bank. That pre-approval is nothing. So it's just their way of locking you into them to get the first look at the deal. And then secondly, you know,

What I try to advise clients with is don't even wait till there's a broker involved. Most of my deals are way before a broker. I've got this whole program we can talk about under Vets.co called Pass the Guide On, where there are methods to get to many business owners way before they ever bring in a broker. And when you can do that, not only do you avoid that stupid question, but you can get a really good deal done with a seller. It's fair.

Jon Stoddard (22:36.45)
Yeah, yeah.

Jon Stoddard (22:43.341)
Yeah. Now you, you taught, touched on, credit credit scores and like, what if these guys come to goes like, I got six 30. did pretty crappy job of saving money or getting, you know, get in debt. That because a big portion of the, you know, acquisition is going to have to be with some kind of SBA lender and they're going to look for six 40 to six 80.

John Panaccione (23:08.558)
Well, you know, none of this is easy by the way, but there's basically three ways to buy a company, right? Method number one is all cash. You know, you're talking private equity VC. You got to be loaded to have an auto to pay cash for a business. And if you're competing with a cash buyer, you're going to lose, right? Sure.

Jon Stoddard (23:26.933)
Hey, hold on, what's that?

Jon Stoddard (23:32.279)
What's up? Where from the glass? Okay. All right. got a John, keep going. Some plumbers are here and then let's go answer this question. And then I got to wrap up. It's like 30. Yeah.

John Panaccione (23:45.878)
Okay. You want to redo this or?

Jon Stoddard (23:50.445)
Now just pause, I'm gonna pause.

John Panaccione (23:52.717)
Okay.

Jon Stoddard (23:54.807)
Just keep it going, I'll cut it out.

Jon Stoddard (25:16.781)
Plumber came in and dog went crazy, knocked over some Halloween decorations and my kids both ran to their room. Yeah, all right, so back to that, the SBA, they don't have the greatest score. You're gonna make sure they have the 640 to 680 or what?

John Panaccione (25:26.988)
Okay.

John Panaccione (25:40.79)
Yeah, so there's what I was saying is there's three kinds of ways to buy a company. The cash, which most of my clients aren't, they wouldn't be clients if they had the cash to buy a business, but oftentimes it. No, but from a seller's perspective, they're the favorite and you can't compete with cash buyers. So, the second one is SBA loan leveraged buyer, right? So that's usually what we're talking about here. And yes, you have to have a minimum credit score. It's in the SBA rules. So you're not getting around that one. So if you got a poor score.

Jon Stoddard (25:48.843)
Right, they're not going to come to you to raise money unless you... well...

John Panaccione (26:10.188)
The third option is a potential for you. And that's when you raise a hundred percent of the amount you need to buy the business. Now in those deals, what you want, and I just got off the phone with someone that fits this category. You want to find a seller that's willing to do a whole hunk and a chunk of seller financing, maybe even up to a hundred percent. And we've done a couple of those, right? So when you have a seller that's for whatever reasons they want to, or can,

are willing to act as your bank. Those are great. So your credit score really doesn't matter at all in those circumstances. And then whatever shortfall you have, we can raise capital for it because credit scores are irrelevant when you, they're relevant, but I mean, they're not critical to raising capital as they are a requirement at a bank.

Jon Stoddard (26:56.427)
Right. You just have to have a good opportunity for the investors that you're going to go out to in your network.

John Panaccione (27:05.856)
Yeah. And you said the key words there in your network. So if anybody tells you, hey, I got a database of investors with their checkbooks out and they're just waiting to cut a deal for a total stranger. And please, I think you'll they'll find you attractive run like run like hell because that's not how it works, man. Raising capital is hard. It has to be done within the rules. And it's usually if you look at the stats, you have some kind of relationship now with veterans, for example.

Jon Stoddard (27:22.573)
Ha

John Panaccione (27:35.852)
You know, I served in the army. think you did too, right? So some other army dude in Oregon might like to stroke me a check because, you know, we served in the same unit or something, right? Folks in minority and women-owned businesses have the same kind of affinity. So that's where you're to get your investors. Outside your friends and family, your affinity group might support you and that's the bet, right? So to run a campaign to raise money, you're going to have to do a lot of hard work and kind of beat the bushes in those areas.

Jon Stoddard (28:04.855)
Yeah. Well, I like this opportunity. There's a couple other people kind of coming out doing these things and it just gives more opportunities for, you know, buyers who don't have the capital to purchase a company from all of these other, you know, sellers that are, you know, growing old and wanting to sell. So just a bigger opportunity. Yeah.

John Panaccione (28:25.624)
Yeah, I agree. It's a huge, exciting opportunity. And when you compare it to startups, you know, got to ask yourself, which path would you rather go down? This acquisition path is actually much easier than actually trying to raise money for a startup. you know,

Jon Stoddard (28:41.069)
my God, I've done that before. I'd never do it again and I don't recommend it to anybody.

John Panaccione (28:46.328)
Yeah. And, know, I'm associated with the co-founder of that to CEO. have an eight week accelerator program there. And then we kind of talk about this a lot, but just, just what I tell startup people. And I did three startups, shame on me, but, I would never do it again. But when you have a startup idea, you know, buy a company that's in the ballpark of what your idea is. And then incubate that idea within the startup and have, have that existing business jumpstart your startup idea. That's a, that's a better way to achieve your vision.

Jon Stoddard (29:13.239)
Yeah, with free cashflow paying your bills too. Yeah. John, how do they get in touch with you? Should they tell you, know, if they call you and say, Hey, I listened to your show with John Top Emine entrepreneur. So how do they get in touch with you?

John Panaccione (29:15.874)
Yeah, absolutely.

John Panaccione (29:29.614)
LinkedIn is probably an easy way I'm on LinkedIn or you can go to folacapital.com and fill out the contact us form there. Either way, you'll get to us and we'll respond.

Jon Stoddard (29:43.831)
Perfect, thanks for coming on the show.

John Panaccione (29:46.498)
Thanks, John. Thanks for having me.