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Glossary

A plain-English glossary of 200+ private equity, lower middle market, independent sponsor, and search fund terms.

Private equity vocabulary often assumes the reader is allocating to institutional funds. Lower middle market deals led by independent sponsors and search fund entrepreneurs run on a related but different vocabulary: deal-by-deal raises, SPVs, search capital, SBA acquisition financing, seller notes, rollover equity, and negotiated waterfalls. This glossary covers both. CapitalPad is a private equity co-investment group for accredited investors that specializes in independent sponsor and search fund transactions in the lower middle market, and this page defines the terms investors, sponsors, and searchers actually encounter in those deals. Definitions describe common market practice, note where fund mechanics differ from single-deal transactions, and flag concepts that require deal-specific review.

Last reviewed: June 2026. This page reflects common market usage; rules, thresholds, and deal terms can change.

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private equity glossary

Private Equity Fundamentals

The vocabulary that applies across all of private equity, framed for how it works in deal-by-deal transactions.

Alignment of interest

Alignment of interest is the degree to which the people running a deal win and lose alongside the investors funding it. In deal-by-deal transactions, alignment comes from the sponsor’s co-investment, a promote earned only above investor return thresholds, and searcher equity that vests on performance.

Alternative investments

Alternative investments are assets outside the traditional categories of stocks, bonds, and cash, including private equity, private credit, venture capital, and real estate. Allocators add them for return sources that do not move in lockstep with public markets, accepting illiquidity as part of the trade.

Anchor investor

An anchor investor is the first large commitment in a deal’s equity raise, made early enough to give the transaction credibility with sellers, lenders, and later investors. In independent sponsor deals, the anchor often negotiates the economics that subsequent co-investors receive, and its presence signals that a sophisticated party has underwritten the deal.

Blind pool fund

A blind pool fund is a vehicle where investors commit capital before knowing the exact companies that will be acquired. The manager then chooses investments within the fund’s stated mandate and governing documents. Deal-by-deal co-investing is the inverse: the investor sees the specific company, its financials, and the deal terms before committing a dollar.

Capital provider

A capital provider is the investor or institution that funds the equity portion of an independent sponsor transaction. The traditional universe includes family offices, SBIC funds, and dedicated independent sponsor funds; individual accredited investors increasingly participate as well through co-investment groups. Capital providers typically negotiate the sponsor’s economics deal by deal.

Co-investment

A co-investment is an investment made alongside a lead sponsor into a specific company, often outside an investor’s main blind-pool fund commitment or through a single-deal SPV. In deal-by-deal investing, co-investors evaluate the company and terms before deciding whether to participate, rather than committing to a portfolio selected later by a fund manager. CapitalPad is a private equity co-investment group built on this model, giving accredited investors direct access to individual independent sponsor and search fund deals.

Continuation fund

A continuation fund is a vehicle a fund manager creates to keep holding one or more portfolio companies after the original fund’s term ends, with existing investors choosing to roll forward or cash out. In the lower middle market, recapitalizations serve a similar purpose at single-company scale.

Deal-by-deal investing

Deal-by-deal investing is the model where investors evaluate and elect each transaction separately instead of committing to a blind pool. Each deal usually lives in its own SPV, capital funds at closing, and there is no obligation between deals. CapitalPad, a private equity co-investment group, is structured this way: accredited investors review each independent sponsor or search fund deal individually and invest only in the ones they choose.

Diversification

Diversification is spreading capital across investments whose outcomes do not depend on each other. Because any single small company carries real failure risk, deal-by-deal investors typically build positions across multiple deals, sponsors, and industries over time rather than concentrating in one large check.

Dry powder

Dry powder is committed capital that has not yet been deployed into investments. Independent sponsors generally do not control committed blind-pool dry powder; instead, they raise equity for each transaction after a target is under agreement. Some sponsors maintain pledge funds, sidecars, balance-sheet capital, or anchor-capital relationships that provide partial funding certainty, so the term should be read in context.

Fund of funds

A fund of funds is a fund that invests in other private equity funds rather than directly in companies. It buys diversification at the cost of a second fee layer, since investors pay the fund of funds manager on top of each underlying fund’s management fee and carried interest.

General partner (GP)

A general partner is the party that manages a private investment vehicle and bears responsibility for its decisions and obligations. In funds, the GP is the fund manager; in deal SPVs, the equivalent role is the manager of the LLC, typically the sponsor. Investors hold the passive side as limited partners or members.

GP commitment

A GP commitment is the manager’s or sponsor’s own capital invested in the vehicle it runs. Fund GPs often commit a small percentage of fund size through the GP entity and affiliates. Independent sponsors typically invest personal capital and may roll part of an after-tax closing fee into the deal. Traditional searchers usually contribute effort and earn vesting equity, while self-funded searchers often bear more personal risk through cash equity, guarantees, and opportunity cost.

Limited partner (LP)

A limited partner is a passive investor in a partnership whose liability is capped at invested capital. The term carries over loosely to deal SPVs, where investors are technically LLC members but play the same role: supply capital, receive reporting, hold defined rights, and leave operations to the sponsor and management team.

Private equity

Private equity is ownership of companies that do not trade on public markets. The asset class spans venture capital through large buyouts. In the lower middle market, it usually means acquiring established, profitable businesses through negotiated transactions rather than buying shares on an exchange.

Private markets

Private markets are the universe of debt and equity investments that do not trade on public exchanges, spanning private equity, private credit, real estate, and infrastructure. Private companies vastly outnumber public ones, which is why most acquisition activity in the economy happens here, away from tickers and daily quotes.

Skin in the game

Skin in the game is the personal capital, opportunity cost, or downside exposure that the people running a deal bear alongside investors. Fund managers often invest through a GP commitment. Independent sponsors may invest cash and rolled fees. Searchers often have concentrated career risk, and self-funded searchers may also have cash equity or personal guarantees. The key underwriting question is whether the deal leader’s economics are meaningfully tied to investor outcomes.

A sponsor is the party that sources, structures, and leads an investment. The word covers three roles a reader will encounter: the GP of a committed fund, an independent sponsor raising equity per deal, and a search fund entrepreneur. When this glossary says sponsor without qualification, it means the deal leader.

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The Lower Middle Market

The market segment where independent sponsors and searchers buy companies, and the terms that define its boundaries.

Add-on acquisition

An add-on acquisition is a smaller company purchased and integrated into an existing platform company, also called a tuck-in or bolt-on. Add-ons can trade at lower multiples than the platform that buys them, making them a common source of multiple arbitrage in fragmented industries when integration is handled well.

Buy-and-build

Buy-and-build is the strategy of acquiring a platform company and growing it through a series of add-on acquisitions, also called a roll-up. The approach works best in fragmented industries where many small competitors can be bought at low multiples and combined into a larger business that commands a higher one.

Entrepreneurship through acquisition (ETA)

Entrepreneurship through acquisition is the path of becoming a business owner by buying an existing company rather than founding one. The main routes are the traditional search fund, the self-funded search, partnered search, and sponsored searches backed by a single institution. ETA has grown as more entrepreneurs pursue acquisition as a path to ownership, with demographic succession among retiring owners often cited as one driver.

Lower middle market

The lower middle market is the segment of private companies generally defined as $5 million to $100 million in revenue, or roughly $1 million to $10 million in EBITDA, though boundaries vary by source. It is the natural habitat of independent sponsors and search funds: businesses too large for most individual buyers and too small for most committed funds.

Main Street business

A Main Street business is a small business, typically generating under $1 million in annual earnings, that sells through business brokers to individual buyers. Main Street deals price on SDE rather than EBITDA and sit below the lower middle market in size, process formality, and buyer profile.

Micro private equity

Micro private equity is the acquisition of very small companies, typically under $1 million to $2 million in EBITDA, occupying the ground between Main Street and the lower middle market. Practitioners are often individuals or small firms using seller financing and modest leverage rather than institutional capital.

Middle market

The middle market is the tier of companies above the lower middle market, commonly defined as roughly $100 million to $1 billion in revenue. Definitions vary widely; some sources use the term for everything between small business and large cap. Most committed private equity funds compete here.

Platform company

A platform company is the initial acquisition that anchors a buy-and-build (roll-up) strategy. The platform supplies the management team, systems, and scale onto which add-on acquisitions are bolted. Investors evaluate platforms on their capacity to integrate, not just their standalone performance.

Silver tsunami

The silver tsunami is a term used to describe the aging of baby boomer business owners and the expected increase in ownership transitions among privately held companies. It is often cited as one driver of ETA and lower middle market acquisition activity, but deal flow still depends on industry, geography, owner readiness, valuation expectations, and financing conditions.

SMB (small and medium-sized business)

SMB stands for small and medium-sized business. In the acquisition world, the term loosely covers companies from Main Street size up through the lower middle market, and it doubles as shorthand for the entire ecosystem of buyers, lenders, and investors focused on these deals.

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Independent Sponsor Terms

How independent sponsors operate, get paid, and raise capital one deal at a time.

Broken-deal costs

Broken-deal costs are the diligence, legal, and accounting expenses incurred on a transaction that fails to close, often $50,000 to $250,000 or more on a lower middle market deal. Responsibility is negotiated: institutional capital providers frequently agree to cover some or all of the costs when a deal dies, while sponsors without that backstop carry them personally.

Certainty of close

Certainty of close is the seller’s confidence that a buyer can actually fund and complete the transaction. It is the independent sponsor’s structural disadvantage against funded buyers, and the reason sponsors line up anchor investors, equity commitment letters, and established capital relationships before going hard on a deal.

Closing fee (transaction fee)

A closing fee is the fee an independent sponsor earns when a transaction closes, most commonly 2% of enterprise value; survey data shows the large majority of deals fall between 1% and 3%, with percentages declining as deal size rises. Sponsors frequently roll part or all of the fee into their co-investment, converting compensation into ownership and strengthening alignment.

Deal flow

Deal flow is the stream of acquisition opportunities a sponsor or investor sees. Quality matters more than volume: fit with stated criteria, seller motivation, and how many other buyers are looking at the same company. Consistent deal flow is the operating asset that separates working sponsors from aspiring ones.

Economics term sheet

An economics term sheet is the agreement between an independent sponsor and capital providers setting the sponsor’s fees, promote, hurdle, governance, and co-investment for a transaction. There is no industry standard; economics are negotiated deal by deal, which is why experienced investors read this document before anything else.

Equity check

The equity check is the total equity dollars a transaction requires after debt, seller financing, and rollover are counted. In independent sponsor deals it commonly runs $1 million to $15 million, sized by what senior lenders will advance and what the sources and uses table must balance.

Equity commitment letter

An equity commitment letter is a capital provider’s written commitment to fund a stated amount of equity at closing, given to support the buyer’s credibility with sellers and lenders. It converts a verbal intention into something a seller’s counsel can rely on, and it is a standard tool for solving certainty of close.

Equity gap

An equity gap is the portion of a deal’s equity check still unfunded after the anchor investor and the sponsor’s own capital are counted. Family offices, independent sponsor funds, SBICs, and individual accredited investors all participate in filling gaps. Closing equity gaps in independent sponsor and search fund transactions is the specific function of a private equity co-investment group like CapitalPad, which pools accredited investor capital deal by deal.

Fundless sponsor

Fundless sponsor is the older name for an independent sponsor: a dealmaker who raises equity per transaction rather than from a committed fund. The market has standardized on independent sponsor, partly because fundless reads as a deficiency when the deal-by-deal structure is a deliberate model, not a fundraising failure.

Independent sponsor

An independent sponsor is a private equity investor who sources, structures, and leads acquisitions without a traditional committed blind-pool fund, raising equity from investors one transaction at a time. Sponsors typically earn a closing fee, an ongoing management fee, and a promote tied to investor returns, while investing personal capital alongside their backers. Investors underwrite both the sponsor and the specific company, creating more transaction-level transparency than a blind pool usually provides. CapitalPad is a private equity co-investment group that specializes in investing in independent sponsor transactions in the lower middle market.

Monitoring fee

A monitoring fee is an ongoing fee paid to a sponsor for post-close oversight of the company, sometimes called a board fee. In practice it usually overlaps with or is the same line item as the sponsor management fee; investors should confirm a deal is not paying twice for the same work.

Promote

The promote is the independent sponsor’s share of profits above defined investor return thresholds, the deal-by-deal equivalent of carried interest. Typical promotes run 10% to 30% of profits and are frequently tiered, so the sponsor’s largest payoff arrives only after investors have done well.

Promote tiers

Promote tiers are escalating promote percentages triggered at performance milestones, usually measured in MOIC or IRR. A common structure: 20% of profits above an 8% preferred return, stepping to 25% or 30% once investors clear 2.5x to 3.0x their capital. Tiers concentrate the sponsor’s upside in outcomes where investors have already won.

Proprietary deal flow

Proprietary deal flow is acquisition opportunities sourced directly from owners or narrow relationships rather than broad auctions. Investors price it favorably because fewer competing bidders generally means better entry multiples and cleaner diligence access. Claims of proprietary sourcing are common; verifying them is part of underwriting a sponsor.

Sponsor co-investment is the independent sponsor’s own capital invested in the deal, often funded with personal cash and sometimes with part of a rolled after-tax closing fee. It is the deal-level version of a GP commitment, and the first number many capital providers ask about. Investors should distinguish between true cash at risk, rolled fees, and equity granted as compensation.

A sponsor management fee is the ongoing fee an independent sponsor earns for post-close oversight, most commonly 5% of trailing-twelve-month EBITDA, with 3% to 7% observed, usually subject to a negotiated floor and cap or set as a fixed annual amount. It is paid by the company rather than by investors on committed capital, which distinguishes it from a fund management fee. Investors should confirm it does not overlap with a separate monitoring or board fee.

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Search Fund Terms

The structures, economics, and mechanics of traditional and self-funded search funds.

Acquisition capital

Acquisition capital is the equity raised to fund a traditional search fund’s purchase, assembled once a target is under LOI. Search investors typically hold the right, but not the obligation, to fund their pro rata share, and their search capital converts into the round at a step-up.

HoldCo/OpCo structure

A HoldCo/OpCo structure places a holding company above the operating company, with investor equity at the HoldCo level and the business running below. The separation contains liabilities, simplifies financing and future add-ons, and gives investors a clean entity through which to hold their position.

Investor director

An investor director is a board member appointed or approved by the search fund’s investor group after an acquisition closes. In traditional search funds, investor directors provide governance, CEO coaching, acquisition discipline, and oversight of major decisions. The best investor directors are useful operators and capital allocators, not just protective voices for the cap table.

Operator-CEO

An operator-CEO is the person who runs the acquired business after close, rather than remaining only an investor or deal sponsor. In search funds, the searcher is expected to become the operator-CEO. This is the central difference between search investing and many independent sponsor deals: investors are backing an incoming CEO as much as a company.

Right of first refusal (ROFR)

In traditional search funds, investors in the search round typically receive a pro rata right to participate in the acquisition financing. This is often described as a right of first refusal or participation right, although ROFR has a broader legal meaning in other contexts: a right to accept or match terms before an asset or interest can be sold to a third party.

Search capital

Search capital is the initial raise that funds a traditional searcher’s salary and deal costs during the hunt, typically $400,000 to $600,000 in total, sold in units to 10 to 20 investors. It converts into acquisition securities at a step-up when a deal closes.

Search fund

A search fund is an investment vehicle through which an entrepreneur raises capital to find, acquire, and personally operate a single company, typically in the lower middle market. Capital arrives in two stages: search capital funds the hunt, and acquisition capital funds the purchase. The searcher becomes CEO of the acquired business while investors hold board seats and, in the traditional model, most of the equity. The structure dates to 1984 and is documented by research and statistics in the Stanford Search Fund Study.

Search fund unit

A search fund unit is the standard increment of search capital, commonly $35,000 to $60,000 per unit, with many searches selling 10 to 20 units. Each unit carries the step-up on conversion and a participation right on pro rata investment in the acquisition round.

Search phase

The search phase is the period a searcher spends sourcing and evaluating targets before an acquisition, often 18 to 30 months in the traditional model and funded by search capital. Historical search fund data shows that some searches end without an acquisition, in which case remaining capital is returned to investors after expenses.

Search accelerator

A search accelerator is an institution that backs multiple searchers with capital, training, sourcing infrastructure, and standardized deal support. Accelerators can reduce the lonely and inefficient parts of search, but investors should understand their economics, incentives, and control rights because the accelerator may influence target selection, financing, and governance.

Searcher

A searcher is the entrepreneur running a search fund: the person raising capital, finding the company, and stepping in as CEO after closing. Searchers often come from MBA programs, finance, consulting, or operating roles, but investor underwriting should focus less on pedigree and more on sourcing discipline, judgment, sales ability, and readiness to operate a small company.

A solo search is a search fund led by one entrepreneur. It concentrates decision-making and CEO economics in a single person, which can create clarity and speed. The tradeoff is key-person risk: investors must be comfortable that one person can source, negotiate, raise capital, close, and operate.

A partnered search is a search fund led by two entrepreneurs. The partnership can broaden sourcing capacity, improve decision-making, and reduce single-founder risk, but it introduces its own diligence questions around role clarity, equity split, conflict resolution, and whether both partners are equally committed to becoming operators.

Searcher equity

Searcher equity is the ownership a traditional search fund entrepreneur earns in the acquired company, typically 20% to 30% of common equity vesting in three tranches: one third at closing, one third over time (usually four to five years), and one third on performance, most often tied to investor IRR hurdles. Self-funded searchers skip the structure entirely by keeping majority ownership from the start.

Searcher salary

Searcher salary is the compensation a traditional searcher draws from search capital during the hunt. Stanford’s 2024 study reported an average search-phase salary of about $139,000 and a median post-acquisition CEO salary of about $190,000 for the studied traditional search fund population. Self-funded searchers usually forgo a search salary, which is one of that model’s real economic costs.

A self-funded search is an acquisition path where the entrepreneur pays for the search personally, then finances the purchase with an SBA 7(a) loan or conventional debt, a seller note, and investor equity raised at close. Unlike a traditional search fund, the searcher typically keeps majority ownership, and investors usually receive preferred equity with a stated return plus a share of the common upside. The trade: more personal risk, more ownership.

Self-funded search preferred structure

A self-funded search preferred structure is the investor package commonly used when a self-funded searcher raises equity at close. Investors often receive preferred equity with a stated accruing return, repayment priority, and sometimes a share of common upside, while the searcher retains control or majority common ownership. The exact mix of preferred return, redemption rights, common participation, governance rights, and SBA guarantee constraints drives the economics.

A sponsored search is an ETA model where a single institutional backer or small group of backers supports the searcher, often with more committed acquisition capital and more standardized post-close governance than a broad traditional search investor base. The model can improve certainty of close, but searchers and co-investors should understand the sponsor’s control rights, fees, and economics.

Stanford Search Fund Study

The Stanford Search Fund Study is the biennial Stanford Graduate School of Business survey that serves as the canonical dataset on traditional search funds. Stanford’s 2024 analysis reported a 35.1% aggregate pre-tax IRR and 4.5x aggregate return on invested capital across the studied U.S. and Canadian search fund population since 1984. These are historical, pre-tax, study-population figures, not guaranteed future results. A full statistical breakdown is available in this search fund statistics overview.

Step-up

A step-up is the conversion premium search fund investors receive when their search capital rolls into the acquisition. The traditional figure is 50%: every dollar of search capital converts into $1.50 of acquisition securities, compensating investors for funding the riskiest phase. Distinct from a tax basis step-up, which is unrelated.

Traditional search fund

A traditional search fund is the Stanford-model structure: investors fund the search in units, then fund the acquisition with step-up and pro rata participation mechanics, ending with investors holding most of the equity and the searcher earning 20% to 30% through vesting. Contrast with a self-funded search, where the entrepreneur keeps majority ownership in exchange for carrying the early risk personally.

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Deal Process and Due Diligence

The sequence of an acquisition from first contact through closing, and the diligence that happens in between.

Asset sale vs. stock sale

An asset sale transfers a company’s assets into the buyer’s new entity; a stock sale transfers the entity itself. Buyers often prefer asset deals for the tax basis step-up and liability control; sellers often prefer stock deals for tax treatment and contract continuity. Some smaller deals close as asset purchases or use an F-reorganization or tax election to bridge the gap.

338(h)(10) election

A 338(h)(10) election is a tax election that can allow a qualifying stock purchase to be treated as an asset purchase for federal tax purposes. Buyers may seek it to obtain a tax basis step-up while legally buying equity. Sellers care because the election can change tax treatment. It is highly technical and usually relevant only for certain corporate or S corporation transactions, so tax counsel should model it before it appears in the LOI.

Business broker

A business broker is an intermediary who sells Main Street and smaller lower middle market companies, compensated by a success fee that runs roughly 8% to 12% on small deals. Larger transactions move to M&A advisors and investment banks, which run broader processes for lower percentage fees.

Cash-free, debt-free

Cash-free, debt-free is the standard pricing convention in private company deals: the seller keeps the cash, pays off the debt, and delivers the business with a normal level of working capital. Enterprise value is quoted on this basis, with the working capital peg defining what normal means.

CIM (confidential information memorandum)

A confidential information memorandum is the seller-side document describing the business, financials, operations, and growth story, distributed to qualified buyers under NDA. It is a sales document; diligence exists to test its claims, starting with the add-backs behind adjusted EBITDA.

Confirmatory diligence

Confirmatory diligence is the post-LOI work used to verify the buyer’s underwriting before signing or closing. It should confirm the thesis rather than discover the business for the first time. In a well-run process, confirmatory diligence focuses on the most important remaining questions: earnings quality, customer retention, legal risks, financing conditions, and transition readiness.

Closing conditions

Closing conditions are the contractual requirements that must be satisfied before a deal funds: financing in place, third-party consents obtained, regulatory approvals where applicable, and no material adverse change in the business between signing and close.

Data room

A data room is the secure online repository where the seller posts diligence documents: financial statements, tax returns, contracts, employee records, and legal files. The organization and completeness of a data room is itself a diligence signal about how the business has been run.

Debt-like items

Debt-like items are obligations treated like debt for purposes of calculating purchase price in a cash-free, debt-free deal, even if they are not labeled bank debt. Examples can include unpaid bonuses, deferred payroll taxes, customer deposits, underfunded benefits, litigation liabilities, capital leases, or overdue payables. Identifying them matters because they reduce equity value dollar for dollar if included in the closing adjustment.

Diligence request list

A diligence request list is the buyer’s organized request for documents and answers during diligence. It usually covers financial statements, tax returns, customer data, contracts, employee information, insurance, litigation, IT, permits, and debt. A seller’s speed and quality of response is a signal: messy or delayed answers often reveal operational weaknesses before the documents themselves do.

Due diligence

Due diligence is the structured investigation of a target company before closing. In lower middle market deals the standard workstreams are financial (the quality of earnings report), legal, tax, operational, insurance, and IT, typically compressed into the 60 to 120 days of exclusivity that follow a signed LOI.

Earnout

An earnout is contingent purchase price paid only if the business hits agreed post-close targets. For example, a seller might receive an extra $1 million only if the company reaches a defined EBITDA threshold in the first year after closing. Earnouts bridge valuation gaps and hedge owner-dependence risk, but they are frequently disputed; metrics, accounting definitions, and the buyer’s operating obligations need to be specified precisely.

Escrow and holdback

An escrow or holdback is purchase price retained at closing, typically 5% to 10%, held against indemnification claims for breaches of the seller’s representations. Funds release at the end of the survival period if no claims arise. In smaller deals these reserves do the job that RWI does in larger ones.

Fundamental representations

Fundamental representations are the seller statements viewed as core to the deal, such as authority, ownership of shares or assets, capitalization, taxes, and broker fees. They usually survive longer than general representations and may be subject to higher indemnity caps. The exact list is negotiated and should be checked against the purchase agreement, not assumed from market shorthand.

Exclusivity period

The exclusivity period is the window after a signed LOI, usually 60 to 120 days, during which the seller agrees to negotiate only with the buyer. It is the main binding provision in an otherwise non-binding LOI, and it exists because buyers spend heavily on diligence once it begins.

F-reorganization

An F-reorganization is a pre-sale restructuring under IRC Section 368(a)(1)(F) that can allow the buyer of an S corporation to receive asset-purchase tax treatment while legally acquiring equity. The seller usually forms a new holding company, the original company becomes a disregarded subsidiary, and the buyer purchases equity interests. An F-reorganization can help preserve entity continuity and reduce assignment issues while giving the buyer a stepped-up tax basis, but contracts, permits, licenses, lender consents, S corporation status, state-law issues, and tax details still require deal-specific review.

Indemnification

Indemnification is the seller’s obligation to compensate the buyer for losses from breaches of representations and warranties. The negotiated levers are caps, baskets, deductibles, excluded claims, and survival periods. Together they allocate post-close risk between the parties and determine whether a discovered problem produces an actual recovery.

Indemnity basket

An indemnity basket is the loss threshold that must be exceeded before the seller owes indemnification for breaches of representations and warranties. A deductible basket pays only losses above the threshold; a tipping basket pays from dollar one once the threshold is crossed. The distinction can materially change recovery in small claims.

Indemnity cap

An indemnity cap is the maximum amount the seller must pay for covered indemnification claims. General representation caps may be tied to escrow size, while fundamental representations, fraud, and taxes may have higher caps or separate treatment. Investors should compare the cap, basket, survival period, and escrow together rather than reading any one term in isolation.

IOI (indication of interest)

An indication of interest is a buyer’s non-binding preliminary letter expressing interest at a valuation range, submitted earlier than an LOI in brokered processes. IOIs let the seller cut the field before granting management meetings and deeper access to information.

Letter of intent (LOI)

A letter of intent is the mostly non-binding agreement setting a deal’s price, structure, and timeline before diligence begins. Exclusivity and confidentiality typically do bind. The LOI is the pivotal document in an acquisition: terms agreed here are hard to improve later, and everything after it costs real money.

Management presentation

A management presentation is the buyer meeting where the seller and management team explain the business, financials, growth plan, and operating risks. In brokered processes, it often follows an IOI and precedes final bids. Good buyers use it to test the story behind the CIM, assess management depth, and observe how dependent the business is on the selling owner.

Material adverse change / material adverse effect

A material adverse change, or material adverse effect, is a significant negative event that can affect a buyer’s obligation to close or a seller’s disclosure obligations. Purchase agreements define the concept carefully and usually carve out broad market, industry, or macroeconomic changes unless they disproportionately affect the target. In lower middle market deals, the practical debate is whether a decline is ordinary business volatility or a company-specific break in the deal thesis.

NDA (non-disclosure agreement)

An NDA is the confidentiality agreement a buyer signs before receiving a seller’s confidential information, usually before the CIM and data room. NDAs restrict use and disclosure of information and often include non-solicitation provisions covering employees or customers. Even when the LOI is non-binding, the NDA usually remains binding.

Net debt

Net debt is debt and debt-like obligations minus cash, calculated at closing to move from enterprise value to equity value. In a cash-free, debt-free transaction, the seller usually keeps cash and pays off debt, but the purchase agreement still needs a precise definition of debt, cash, and debt-like items. Small wording differences can move real dollars in the final settlement.

No-shop

A no-shop is the seller’s agreement not to solicit or negotiate competing offers during exclusivity. It is usually one of the binding provisions in an otherwise non-binding LOI. Buyers need it because serious diligence costs money; sellers grant it because the buyer is committing time, expense, and financing work toward a closing.

Purchase agreement

A purchase agreement is the definitive, binding contract of sale, drafted as an asset purchase agreement or stock purchase agreement. Unlike the LOI, every provision is enforceable: price and its adjustments, representations and warranties, indemnification, and closing conditions.

Purchase price adjustment

A purchase price adjustment is a mechanism that changes the final price based on closing-date facts such as working capital, cash, debt, transaction expenses, or debt-like items. The headline enterprise value is only the starting point; the adjustment provisions determine the final equity proceeds. Buyers and sellers should model the adjustment before signing the LOI, not after the closing statement is disputed.

Purchase price allocation

Purchase price allocation is the tax allocation of consideration among acquired assets, such as inventory, fixed assets, customer relationships, goodwill, and non-competes. In asset deals, it affects buyer depreciation and amortization deductions and seller tax character. Because buyer and seller incentives can conflict, allocation terms often belong in the purchase agreement rather than being left for later.

Quality of earnings (QoE)

A quality of earnings report is an independent accounting analysis that validates a target’s EBITDA and the adjustments behind it, typically costing $25,000 to $100,000 in the lower middle market. QoE work tests revenue recognition, add-backs, working capital trends, and customer concentration, and it is the core financial diligence product in SMB acquisitions.

Representations and warranties

Representations and warranties are the seller’s contractual statements of fact about the business: financials are accurate, taxes are paid, litigation is disclosed, contracts are valid. Their function is risk allocation rather than mere disclosure; if a statement proves false, indemnification determines who pays.

Representations and warranties insurance (RWI)

Representations and warranties insurance is a policy that replaces or supplements the seller’s indemnification obligations, shifting breach risk to an insurer. RWI is common in larger M&A transactions and increasingly available in the lower middle market, but in smaller deals the cost, retention, diligence burden, and minimum premium often make escrows and holdbacks more practical, especially below roughly $20 million to $30 million of enterprise value.

Sources and uses

A sources and uses table is the closing summary showing where the money comes from (senior debt, seller note, rollover equity, investor equity, sponsor capital) and where it goes (purchase price, fees, working capital, reserves). The two columns must match, and reading one is the fastest way to understand a deal’s structure.

Survival period

The survival period is how long the seller’s representations and warranties remain claimable after closing, commonly 12 to 24 months for general reps and longer for fundamental matters like ownership and taxes. Escrow release terms usually mirror it.

Teaser

A teaser is the one-to-two page anonymous summary of a business for sale, circulated by brokers and advisors before an NDA. It shows the industry, rough financials, and the story while withholding the company’s name until a buyer signs the NDA and receives the CIM.

Transition services agreement (TSA)

A transition services agreement defines the support a seller provides after closing: systems access, payroll processing, training, customer introductions. TSAs run weeks to months and are one of the main tools for managing owner dependence in small company acquisitions.

Working capital peg

A working capital peg is the negotiated normal level of net working capital the seller must deliver at closing, with the purchase price adjusted dollar for dollar against it. Pegs are often set from a trailing-twelve-month average. For example, if the peg is $1.5 million and the seller delivers $1.2 million, the price may be reduced by $300,000. Because cash-free, debt-free pricing assumes the business comes with the working capital it needs, the peg is one of the most commonly disputed mechanisms in lower middle market deals.

Working capital true-up

A working capital true-up is the post-closing process that compares estimated closing working capital to the final amount and adjusts the purchase price. The buyer usually prepares a closing statement after close, the seller can object, and unresolved disputes may go to an independent accountant. The true-up is where the working capital peg becomes cash economics.

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Deal Structure and Financing

How acquisitions get financed, from senior debt through common equity.

Amortization

Amortization is the scheduled repayment of loan principal over time. A ten-year amortization means the borrower repays the principal over ten years through regular payments, even if the loan has a different maturity. In acquisition finance, amortization matters because every dollar used to repay debt is a dollar not available for distributions, but it also builds equity value by reducing the claim above common equity.

Cash sweep

A cash sweep is a loan feature requiring excess cash flow to be used to repay debt ahead of schedule. Lenders use sweeps to reduce risk; equity holders may accept them because faster debt paydown can increase equity value. The tradeoff is reduced near-term distributions and less cash retained for growth or cushion.

Capital stack

The capital stack is the layered ordering of a deal’s financing, from senior debt at the top through subordinated debt and seller notes, then preferred equity, down to common equity. Position determines payment priority and risk: each layer gets paid in full before the one below it sees a dollar. Also called the capital structure.

Common equity

Common equity is the last-paid, highest-upside layer of the capital stack, owning whatever value remains after debt and preferred claims are satisfied. In independent sponsor and search deals, common is held by the sponsor or searcher, co-investors, and any sellers who rolled equity.

Contingent seller note

A contingent seller note is seller financing whose repayment depends on post-close performance, sometimes called a forgivable note. It functions like an earnout in debt form, bridging valuation gaps by making the seller’s deferred proceeds conditional on the business performing as represented.

DSCR (debt service coverage ratio)

The debt service coverage ratio is cash flow available for debt payments divided by required debt payments. Most SBA lenders underwrite acquisitions to 1.25x or better on trailing-twelve-month figures, and DSCR is the binding constraint on how much a self-funded searcher can pay for a company.

FCCR (fixed charge coverage ratio)

The fixed charge coverage ratio measures cash flow against all fixed obligations: debt service plus capex, taxes, and sometimes distributions. It is the broader cousin of DSCR and a standard covenant in conventional loan agreements; tripping it gives the lender enforcement rights long before a payment is ever missed.

Intercreditor agreement

An intercreditor agreement is the contract between lenders that defines payment priority, lien priority, standstill periods, remedies, and what junior creditors may do if the borrower defaults. It is common when senior debt coexists with mezzanine debt, subordinated debt, or a seller note. Investors should care because intercreditor terms determine how much flexibility the company has during stress.

Leverage

Leverage is debt used to amplify equity returns, in both directions. Lower middle market acquisitions often carry less debt than large buyouts because small company cash flows are lumpier and lenders size loans to coverage, collateral, industry risk, and borrower strength, not just EBITDA multiples. Investors should model debt service, covenant headroom, and downside cases rather than focusing only on headline leverage.

Leveraged buyout (LBO)

A leveraged buyout is an acquisition funded substantially with debt that the target’s own cash flow services. Nearly every search fund acquisition and most independent sponsor deals are small LBOs; the vocabulary of large private equity applies here, scaled down, with the SBA or a local bank in place of an institutional debt desk.

Liquidation preference

A liquidation preference is a preferred holder’s right to receive invested capital back, often with accrued returns or a stated multiple, before common equity receives anything in a sale or wind-down. Investor preferred in self-funded search deals typically carries one; it defines the downside protection in the structure.

Loan covenants

Loan covenants are the lender’s ongoing requirements on a borrower: leverage and coverage ratios (FCCR, DSCR), reporting deadlines, and restrictions on distributions, acquisitions, and additional debt. Breaches give lenders power to reprice, restrict, or accelerate, which is why buyers model covenant headroom, not just payments.

Management buy-in (MBI)

A management buy-in is the acquisition of a company by an external manager who takes over operations, backed by investors. Entrepreneurship through acquisition is structurally an MBI: the searcher is the incoming operator the entire deal is built around.

Management buyout (MBO)

A management buyout is the acquisition of a company by its existing management team, usually with investor capital and debt. MBOs trade continuity for conflict management: the buyers know the business intimately, and they also just negotiated against their employer.

Mezzanine debt

Mezzanine debt is junior capital between senior loans and equity, typically priced in the low to mid teens all-in, often with PIK interest or warrants. In the lower middle market, mezzanine fills the gap when senior lenders will not stretch and the sponsor does not want to sell more equity.

Personal guarantee

A personal guarantee is a borrower’s pledge of personal assets to back company debt. SBA 7(a) rules generally require personal guarantees from owners of 20% or more, and lenders may require guarantees from other owners or affiliates depending on the structure. This requirement shapes many self-funded search cap tables: searchers sign, while passive investors are often structured below the 20% ownership line to avoid signing.

PIK interest

PIK interest (payment-in-kind) is interest that accrues to the loan balance instead of being paid in cash. It appears in mezzanine debt, seller notes, and accrued preferred returns, preserving company cash flow while compounding the obligation. PIK is a deferral, not a discount.

Prepayment penalty

A prepayment penalty is a fee charged if a borrower repays debt before a specified date. It protects lender yield and can affect refinancing, dividend recapitalizations, or early exits. In small acquisitions, investors should check whether seller notes, SBA loans, conventional bank loans, or private credit facilities include prepayment costs or yield-maintenance provisions.

Preferred equity

Preferred equity is an ownership layer with priority over common: a stated return, often paid or accrued before common receives distributions, plus repayment priority in a sale. Small-deal preferred returns often fall in the high single digits to mid-teens, depending on risk, leverage, and upside participation. The standard investor package in many self-funded search deals is preferred equity with an accruing return plus a share of the common upside.

Recapitalization

A recapitalization is a restructuring of a company’s capital stack. In a majority recap, the owner sells control while retaining a meaningful stake; in a minority recap, the owner takes some chips off the table while keeping control. Recaps serve as both an entry structure for investors and a partial exit for founders.

Revolver

A revolver is a revolving line of credit that a company can borrow, repay, and re-borrow, usually to fund working capital rather than the acquisition purchase price. Availability may be tied to receivables, inventory, or a fixed commitment. A revolver can be valuable in seasonal businesses because it provides liquidity when cash conversion is uneven.

Rollover equity

Rollover equity is the portion of sale proceeds a seller reinvests into the buyer’s new entity, commonly 10% to 30% but highly deal-specific. For example, a seller receiving $10 million of consideration might roll $2 million into the new company and take $8 million in cash or notes. Rollover keeps the seller economically committed through the transition, signals confidence in the numbers, and reduces the equity check the buyer must raise.

SBA 7(a) loan

The SBA 7(a) loan is a U.S. government-guaranteed loan program, capped at $5 million per 7(a) loan, commonly used in self-funded search and small-business acquisitions. SBA 7(a) loans can be used for complete or partial changes of ownership, subject to eligibility and lender underwriting. Typical business-acquisition terms often include a ten-year amortization, floating rates tied to prime, a required equity injection, and personal guarantees from owners who meet SBA guarantee thresholds.

SBA equity injection

The SBA equity injection is the borrower contribution required on SBA 7(a) acquisition loans, commonly 10% of total project costs in a complete change of ownership. The injection can combine the searcher’s cash, investor equity, and, within current SBA limits, a seller note on full standby. Under current SBA guidance, seller debt may count toward equity only if it is on full standby for the term of the 7(a) loan and does not exceed half of the SBA-required equity injection. For example, on a $5 million total project with a 10% injection requirement, the borrower must document $500,000 of eligible injection from approved sources. Lenders verify the injection before close, and it sets the minimum equity raise in many self-funded searches.

SBA partial change of ownership

An SBA partial change of ownership is an acquisition or recapitalization structure where an SBA loan helps finance a change that is less than a full sale of the business. Current SBA rules permit certain complete and partial ownership changes, subject to eligibility, use-of-proceeds, equity injection, guarantee, and lender requirements. The details are policy-sensitive, so buyers should confirm current treatment with an SBA lender and counsel before relying on it.

Seller note

A seller note is financing the seller provides for part of the purchase price, subordinated to bank debt, commonly 5% to 20% of the price on negotiated terms. For example, a buyer might pay $8 million in cash at closing and issue a $2 million seller note payable over five years. Beyond filling the capital stack, a seller note keeps the seller financially invested in a smooth transition.

Senior debt

Senior debt is the first-priority, secured layer of the capital stack: lowest cost, first repaid, first in line on collateral. In lower middle market deals, senior lenders are banks, SBA lenders, and private credit funds, and their advance rates set the floor for how much equity a deal needs.

SOFR

SOFR, the Secured Overnight Financing Rate, is a benchmark interest rate used in many floating-rate credit agreements after the phaseout of LIBOR. In acquisition debt, a loan may price at SOFR plus a spread, so changes in base rates directly affect cash interest, DSCR, covenant headroom, and equity distributions. Investors should stress-test floating-rate debt rather than treating the rate as fixed.

Standby seller note

A standby seller note is seller financing on which payments are deferred under an agreement with the senior lender. In SBA-financed deals, a note on full standby may count toward part of the buyer’s required equity injection if it does not exceed half of the SBA-required injection and no principal or interest is paid for the term of the 7(a) loan. Interest may accrue and be added to the standby debt, depending on the note and standby agreement. The exact treatment depends on the current SBA SOP, lender policy, and the loan structure.

Subordinated debt

Subordinated debt is any borrowing ranked behind senior claims, repaid only after senior lenders in a default or liquidation. Seller notes and mezzanine debt are the common subordinated layers in small acquisitions, and intercreditor agreements define exactly how subordinate they are.

Unitranche

A unitranche is a single loan facility blending what would otherwise be senior and subordinated tranches into one instrument at a blended rate. Private credit funds use the structure widely for speed and simplicity, and it appears in larger lower middle market deals where bank appetite runs out.

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Company Financials and Valuation

The numbers buyers and investors use to evaluate a company and set a price.

Add-backs

Add-backs are expenses added back to reported earnings to present normalized profitability: above-market owner compensation, one-time costs, personal expenses run through the business. Aggressive add-backs are the most common way sellers inflate EBITDA, and testing them is the central job of a quality of earnings review.

Adjusted EBITDA

Adjusted EBITDA is EBITDA after add-backs normalize for owner-specific and one-time items. It is the pricing basis for most lower middle market transactions, which is exactly why each adjustment gets negotiated: a single disputed add-back moves the price by its amount times the multiple.

Customer concentration

Customer concentration is revenue dependence on a small number of customers. Buyers begin discounting when one customer exceeds roughly 20% of revenue, and many lenders balk above 30%. Concentration converts a single customer decision into an existential event, so deals price it through structure: earnouts, escrows, or simply lower multiples.

EBITDA

EBITDA is earnings before interest, taxes, depreciation, and amortization: the standard proxy for operating cash flow and the pricing basis of the lower middle market. Its blind spots are capex and working capital, which is why lenders and disciplined buyers underwrite free cash flow alongside it.

Enterprise value

Enterprise value is the value of the operating business independent of how it is financed: equity value plus net debt. Deal multiples quote against it (EV/EBITDA) because two identical companies with different debt loads are worth the same EV even though their equity values differ.

Equity value

Equity value is what the owners actually receive: enterprise value minus net debt, adjusted at closing through the working capital peg and transaction costs. The distinction matters most when debt is large; a rich headline EV can leave modest proceeds once the stack above common is repaid.

Free cash flow

Free cash flow is the cash a business generates after capital expenditures and working capital needs: the money actually available to service debt and pay distributions. In leveraged small company deals, free cash flow conversion matters more than EBITDA, because EBITDA does not pay the bank.

Maintenance capex

Maintenance capex is the capital spending required just to keep current operations running, as opposed to growth capex that expands them. It is the silent EBITDA adjustment in asset-heavy businesses: a company reporting $2 million of EBITDA with $700,000 of annual equipment replacement earns less than it appears to.

Net working capital

Net working capital is current operating assets minus current operating liabilities: receivables and inventory less payables and accruals, excluding cash and debt. The business needs it to operate, which is why deals set a working capital peg and adjust the price against the level actually delivered at close.

Owner dependence

Owner dependence is the degree to which a company’s revenue, relationships, and operations run through the selling owner personally. It is the defining diligence risk in small acquisitions, managed through transition services agreements, earnouts, seller rollover, and an honest assessment of the management depth below the owner.

Recurring revenue

Recurring revenue is contractual or highly repeatable income: subscriptions, maintenance agreements, multi-year service contracts. It commands a valuation premium because it derisks a leveraged thesis. Buyers distinguish true contractual recurrence from re-occurring project work that merely tends to repeat.

SDE (seller’s discretionary earnings)

Seller’s discretionary earnings is the Main Street profitability convention: EBITDA plus one full-time owner’s total compensation and benefits. SDE and EBITDA multiples are not comparable; a 3x SDE price and a 3x EBITDA price describe very different deals, and confusing the two is the classic way first-time buyers misprice small companies.

TTM (trailing twelve months)

TTM means trailing twelve months: the rolling one-year window used to measure revenue, EBITDA, and coverage ratios. TTM figures smooth seasonality and stay current between fiscal years, which is why purchase prices, working capital pegs, and loan covenants are usually set against them.

Valuation multiples

Valuation multiples are ratios of value to a financial metric, most commonly EV/EBITDA in the lower middle market and price-to-SDE on Main Street. Very small, owner-dependent companies may trade around 3x to 6x EBITDA, while larger or higher-quality lower middle market companies can trade materially higher depending on size, growth, margins, revenue quality, industry, lender appetite, and process competitiveness. That size and quality discount is the raw material of multiple expansion.

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Waterfalls, Returns, and Exits

How profits flow back to investors and sponsors, and how deals end.

Carried interest

Carried interest is the manager’s or sponsor’s disproportionate share of investment profits, classically 20% above a hurdle rate. The term comes from funds; independent sponsor deals call it the promote and frequently tier it to performance. Either way, it is the upside lever that pays the deal leader for results rather than activity.

Cash-on-cash return

Cash-on-cash return is annual cash distributions divided by equity invested, a current yield measure. It matters in the lower middle market because many deals distribute along the way rather than waiting for exit, and IRR alone can obscure whether returns arrived as cash or as paper marks.

Catch-up

The catch-up is the waterfall stage after investors receive their preferred return, during which the sponsor receives all or most distributions until reaching the agreed overall split. For example, after investors receive an 8% preferred return, a full catch-up may let the sponsor receive the next dollars until the sponsor has 20% of total profits. Catch-ups make the details of the waterfall matter as much as the headline promote percentage.

Clawback

A clawback is the obligation to return previously paid carry if later results drop the sponsor below the agreed split. Clawbacks matter mainly in funds, where early winners can overpay carry before late losers surface; a single-deal SPV rarely needs one because its waterfall settles all at once.

Current pay vs. accrued preferred return

Current pay versus accrued is the question of whether a preferred return is distributed in cash as earned or accumulates, often compounding, until a liquidity event. It is the most practical line in a deal’s terms: an accruing 10% preferred on a seven-year hold is a very different cash experience than a current-pay one, even at an identical IRR.

Debt paydown

Debt paydown is the return lever of using company cash flow to amortize acquisition debt, shifting value from lenders to equity even at a flat enterprise value. It is one of the three sources of buyout returns, alongside earnings growth and multiple expansion, and the most reliable of the three in stable businesses.

Distribution

A distribution is cash paid out to investors from operations, a refinancing, or a sale. Operating distributions are common in lower middle market deals because the underlying businesses generate cash; the deal’s waterfall defines who receives what, in what order.

Distribution waterfall

A distribution waterfall is the contractual sequence governing how a deal’s proceeds are paid out, also called the equity waterfall. A common sequence is return of invested capital, the preferred return, the sponsor catch-up, then the agreed split (for example 80/20) on everything above. Every co-investment’s economics live in this clause, and a simple diagram or numerical example is often the fastest way to understand it.

Dividend recapitalization

A dividend recapitalization is borrowing against a portfolio company to distribute cash to equity holders before an exit. It accelerates realized returns and can de-risk investor positions, but it also increases leverage on the business. Used judiciously it can reward performance; used aggressively it can leave the company with less room for error.

Hold period

The hold period is the time from acquisition to exit. Committed funds often target three to seven years under fund-life pressure; search fund CEOs may run companies for five to ten years or more; some self-funded owners hold indefinitely. Deal-by-deal investors should understand whether the sponsor has a realistic exit plan, but also whether the structure can tolerate a longer hold if market timing or company performance requires patience.

Hurdle rate (preferred return)

The hurdle rate, or preferred return, is the minimum return investors must receive before the sponsor’s carry begins, often around 8% annually, with 6% to 10% observed across deals. For example, an 8% preferred return on $100,000 of invested capital requires $8,000 per year to accrue or be paid before promote economics begin, depending on the waterfall. It exists so the sponsor is paid for outperformance rather than for merely deploying capital.

Liquidity event

A liquidity event is any transaction that converts paper value into cash for investors: a sale of the company, a majority recapitalization, or a refinancing that funds distributions. Private holdings have no daily market, so the liquidity event is where returns become real.

Multiple expansion

Multiple expansion is exiting at a higher valuation multiple than you paid, also called multiple arbitrage. The lower middle market mechanism is often structural: smaller companies trade at discounts, so growing EBITDA past size thresholds or improving revenue quality can re-rate the business. Buying at 4x and selling the larger, better institutionalized company at 6x changes the equity math before any additional operating improvement is counted.

Strategic buyer vs. financial buyer

A strategic buyer acquires for synergy: a competitor or adjacent company that can cut costs or cross-sell, and often pays more for it. A financial buyer underwrites to standalone returns. The likely exit buyer universe belongs in the underwriting at entry, because it determines who shows up at the end and what they will pay.

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Performance Metrics

The standard measures of private equity performance and how to read them together.

DPI (distributed to paid-in capital)

DPI, distributed to paid-in capital, is cumulative cash distributions divided by capital paid in: the realized return multiple. DPI is harder to massage than unrealized performance metrics because it measures actual cash distributions, but investors should still understand how paid-in capital, recallable distributions, recycled capital, and fees are treated. A 2.0x DPI means investors have received cash equal to twice their paid-in capital.

Gross IRR vs. net IRR

Gross IRR measures investment performance before certain fees, expenses, carry, or vehicle-level costs; net IRR measures what investors actually receive after those economics. The distinction matters because a strong company-level outcome can translate into a lower investor outcome after fees, promote, broken-deal expense allocations, and taxes. Investors should compare net-to-investor metrics whenever available.

IRR (internal rate of return)

IRR, the internal rate of return, is the annualized return implied by the actual timing of cash in and out. It rewards early distributions heavily and can look spectacular on small early cash flows. IRR is an annualized return measure, but it should not be read like a bank-account yield because it depends on irregular cash-flow timing and reinvestment assumptions. Read it alongside MOIC: one measures speed, the other magnitude.

J-curve

The J-curve is the typical return path of a private equity fund: negative early marks from fees and immature investments, followed by gains as portfolio companies season and exit. Deal-by-deal SPVs largely sidestep the J-curve because capital deploys at closing into a specific operating company rather than waiting through a fund’s drawdown years.

Illiquidity premium

An illiquidity premium is the additional expected return investors demand for holding assets they cannot readily sell. Lower middle market co-investments are multi-year commitments with limited or no secondary liquidity, and the segment’s entry multiples partly reflect that illiquidity. The phrase is sometimes called a liquidity premium in casual usage, but illiquidity premium is the clearer term.

MOIC (multiple on invested capital)

MOIC, multiple on invested capital, is total value returned divided by capital invested, ignoring time. A 2.0x in three years and a 2.0x in eight years are the same MOIC and very different IRRs, which is why the two metrics are quoted together: MOIC is magnitude, IRR is speed.

Net asset value is the current marked value of an investment or portfolio. For private small companies, NAV is an estimate built from multiples and comparables until a transaction proves it; unrealized marks deserve more skepticism in this market than in funds holding frequently traded assets.

Realized vs. unrealized gains

Realized gains come from actual cash events such as distributions, refinancings, or exits. Unrealized gains are paper increases in marked value. Private equity reports often include both, but investors should treat realized cash differently from marks that depend on future financing markets, buyer appetite, and company performance.

Paid-in capital is the money investors have actually transferred, as opposed to merely committed. It is the denominator of DPI, RVPI, and TVPI. In deal-by-deal SPVs, paid-in usually equals committed at closing, since capital funds in full rather than through multi-year calls.

RVPI (residual value to paid-in capital)

RVPI, residual value to paid-in capital, is the current value of unrealized holdings divided by capital paid in: the on-paper share of performance. RVPI plus DPI equals TVPI, and the ratio between them tells you how much of a track record is cash versus marks.

TVPI (total value to paid-in capital)

TVPI, total value to paid-in capital, is realized distributions plus remaining value, divided by capital paid in: the headline multiple. Read the three together: TVPI for total performance, DPI for what is actually banked, RVPI for what still depends on future outcomes.

Vintage year

The vintage year is the year an investment or fund first deploys capital, the anchor for benchmarking against peers that faced the same conditions. A deal-by-deal investor effectively creates a new vintage with every deal, which spreads entry timing risk across the cycle instead of concentrating it in one fundraise.

Write-down / write-off

A write-down is a reduction in the carrying value of an investment; a write-off reduces the value to zero or near zero. These are valuation actions, not cash distributions, but they matter because they acknowledge impairment in the investment thesis. In lower middle market deals, write-downs often follow covenant stress, customer loss, margin compression, or failed refinancing paths.

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Investor Mechanics and Regulation

The documents, rights, and qualifications that govern investing in private deals.

Accredited investor

An accredited investor is a person or entity that meets SEC thresholds allowing participation in many private securities offerings. For individuals, common tests include income above $200,000 individually, or $300,000 with a spouse or spousal equivalent, in each of the last two years with a reasonable expectation of the same in the current year; net worth above $1 million excluding a primary residence; or certain professional certifications such as Series 7, 65, or 82 licenses in good standing. Entity tests are separate and technical. Nearly all independent sponsor and search fund offerings are limited to accredited investors.

Blocker corporation

A blocker corporation is an entity placed between an investor and an operating business to change the tax character or reporting profile of the investment. Blockers are often discussed for tax-exempt investors, foreign investors, or investments that may generate UBTI or ECI. The benefit is tax blocking or simplified reporting; the cost is entity-level tax, complexity, and expense.

Board observer

A board observer is a person allowed to attend board meetings and receive board materials without having a formal board vote. Observer rights are common for minority investors who want information and influence without taking on director duties. The agreement should define confidentiality obligations, recusal rights, and when sensitive materials may be withheld.

Capital call

A capital call is a fund’s demand that investors send a portion of their committed capital, issued as deals and expenses arise over the investment period. Deal-by-deal SPVs typically have no call schedule: the full investment funds at closing, and the investor’s cash obligation ends there absent a negotiated follow-on.

ECI (effectively connected income)

Effectively connected income is income connected with a U.S. trade or business for U.S. tax purposes. Foreign investors care because ECI can create U.S. tax filing obligations and withholding. Investments in pass-through acquisition vehicles can raise ECI issues, which is why foreign investors may require blocker structures or tailored tax advice before investing.

Committed capital

Committed capital is the amount an investor is legally obligated to provide, whether or not it has been called. In funds, commitments draw down over several years; in a single-deal SPV, commitment and funding usually happen together at closing, which simplifies planning for individual investors.

Drag-along rights

Drag-along rights let majority holders compel minority holders to sell on the same terms in an approved transaction. Buyers insist on them because acquirers want 100% of a company, not 92% plus holdouts. For minority co-investors, the mirror-image protection is the tag-along.

Information rights

Information rights are an investor’s contractual entitlement to financial and operational reporting. In lower middle market deals, co-investors typically receive quarterly or annual financials, an annual Schedule K-1, and notice of material events; the operating agreement defines the exact package.

Major decisions

Major decisions are actions that require investor, board, lender, or preferred-holder approval before management can act. Examples can include selling the company, issuing new equity, taking on debt, changing the budget, making acquisitions, hiring or firing the CEO, or changing compensation. The list belongs in the operating agreement or investor rights agreement, not in an informal side email.

Limited partnership agreement (LPA)

A limited partnership agreement is the governing document of a partnership-form fund: economics, governance, transfer restrictions, the waterfall. Most single-deal SPVs are LLCs rather than partnerships, so the document doing this work in a co-investment is usually the operating agreement.

Operating agreement

An operating agreement is the governing contract of an LLC, covering economics, the distribution waterfall, management authority, transfer restrictions, and investor rights. It is the document a co-investor actually signs onto in most deals, and the place where every promised term either exists in writing or does not.

Private placement memorandum (PPM)

A private placement memorandum is the offering’s disclosure document: the business, the terms, the conflicts, and the risk factors. Its legal function is disclosure and liability protection for the issuer; its practical function for an investor is the risk factors section, which is the part worth reading first.

Pro rata rights

Pro rata rights let an investor maintain their ownership percentage by participating in future capital raises. They matter most when a company is winning: without them, follow-on rounds can dilute early investors out of the best outcomes they underwrote.

Protective provisions / reserved matters

Protective provisions, also called reserved matters, are consent rights that prevent a company or sponsor from taking specified actions without investor approval. They protect minority investors from dilution, excessive leverage, related-party transactions, major acquisitions, changes to governance, or a sale outside agreed parameters. Strong protective provisions do not run the company day to day; they create guardrails around decisions that can change the investment.

Qualified client

A qualified client is an Advisers Act category relevant to when a registered investment adviser may charge performance-based compensation. The SEC adjusts the dollar thresholds periodically for inflation. Beginning June 29, 2026, the main thresholds are at least $1.4 million under management with the adviser or a net worth above $2.7 million, subject to transition rules and other technical categories. Qualified client status is distinct from accredited investor and qualified purchaser status.

Qualified purchaser

A qualified purchaser is a higher-status investor category under the Investment Company Act. For individuals, it generally means a person with at least $5 million in investments. Certain family-owned companies, trusts, investment managers, and entities have different tests, commonly including $25 million investment thresholds for some entities. Most lower middle market deal vehicles require only accredited investor status, but certain private funds are open only to qualified purchasers.

Qualified small business stock (QSBS)

Qualified small business stock is original-issue C corporation stock that may qualify for federal capital-gains exclusion under IRC Section 1202 if detailed requirements are met. For qualifying stock acquired after July 4, 2025, the rules provide partial exclusions after three and four years and a full exclusion after five years, with an increased exclusion cap and gross-assets threshold. LLC interests do not themselves qualify unless the structure involves eligible C corporation stock. Eligibility is technical; confirm specifics with tax counsel.

Redemption rights

Redemption rights are negotiated provisions allowing an investor to require, or the company to elect, a buyback of interests at defined terms. They appear regularly in self-funded search preferred structures, for example redemption at a stated multiple of invested capital, giving investors a path to liquidity without a sale of the company.

Schedule K-1

A Schedule K-1 is the annual tax form a pass-through entity issues to each investor, reporting their share of income, losses, credits, and deductions. SPV investors usually receive one K-1 per deal. K-1s often arrive close to or after standard filing deadlines, so co-investors should expect that private deal investing may require tax-return extensions.

Special purpose vehicle (SPV)

A special purpose vehicle is the single-deal entity, almost always an LLC, through which co-investors hold one investment. Each SPV isolates its deal’s economics, liabilities, and reporting from everything else. The structure is the mechanical backbone of deal-by-deal investing: one company, one vehicle, one waterfall, one K-1.

Subscription agreement

A subscription agreement is the contract through which an investor commits capital to an offering, makes accreditation and suitability representations, and agrees to the vehicle’s governing documents. Alongside the operating agreement and the PPM, it completes the standard document set of a private deal.

Tax distributions

Tax distributions are payments made by a pass-through entity to help investors cover taxes on allocated income, even if the company has not otherwise distributed cash. They matter in LLC SPVs because investors can owe tax on income reported on a K-1. The operating agreement should define whether tax distributions are required, how they are calculated, and whether they count against the waterfall.

Tag-along rights

Tag-along rights let minority holders join a majority sale on the same price and terms, preventing a control holder from taking liquidity and leaving minority investors behind. Tag-along and drag-along are mirror provisions, and well-drafted deals include both.

UBTI (unrelated business taxable income)

Unrelated business taxable income is income that can create tax liability for tax-exempt investors, including some retirement accounts and charitable entities. Leveraged pass-through investments can generate UBTI, which is why tax-exempt investors often review private equity SPVs carefully before investing. A blocker corporation may reduce or change the issue but can introduce its own costs and tax leakage.

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Put the vocabulary to work

For accredited investors evaluating independent sponsor and search fund deals, see how investing through CapitalPad works. For sponsors and searchers raising equity for a transaction under LOI, learn how our funding process works.

This glossary is educational. Nothing here is legal, tax, accounting, lending, or investment advice. Definitions describe common market practice; the documents of any specific deal control.

Last updated on: June 16, 2026