How does an equity step-up work in a search deal?

Why do step-ups exist?

Because money spent before a deal exists can be lost entirely. In the 2026 Stanford study, 58% of traditional search funds bought a company. The rest had not bought one, and search capital spent without a deal has nothing to convert into.

Investors who fund that risk want more than the investors who arrive once a deal is signed and diligenced. The step-up is how they get it. It is a conversion rate, not a fee. The early money converts into the same security as the new money, but at a better price.

How does a step-up work in a traditional search fund?

Search investors fund a budget, typically $400,000–$600,000, to pay the searcher and the costs of looking. When the searcher signs a deal, those investors usually get the right to invest in the acquisition. Their search capital rolls into the deal at a step-up, often 150%.

The searcher's equity sits outside this. A traditional searcher typically earns about 20–30% of the common equity in tranches: some at closing, some over time and some on performance. The step-up decides how the investors' share is divided among the investors.

How does a 2x step-up work in a self-funded deal?

A self-funded searcher pays for the search. But a deal can still need outside money before closing, for example to pay for a Quality of Earnings report, legal work or deposits. As of October 2026, SBA rules require a lender-commissioned QoE for Initial Acquisitions with a price of $3 million or more, and QoE proposals for SBA deals run $7,500–$30,000 or more.

Investors who fund those costs take the risk that the deal dies in diligence. In current self-funded terms, that capital commonly gets a 2x step-up, down from about 3x. Term sheets define which dollars qualify, so read yours closely.

Worked example: two step-ups, step by step

The deal sizes and amounts are assumptions. The step-up rates and the searcher's ownership range come from the sources below.

Traditional search fund

1. Search investors fund $500,000. The search succeeds.
2. Step-up at 150%: $500,000 × 1.5 = $750,000 of credit in the deal.
3. The deal needs $8,000,000 of new investor equity. Total investor credit: $8,000,000 + $750,000 = $8,750,000.
4. The searcher earns 25% of the common over time, so investors hold 75%.
5. Search investors' share of the investor pool: $750,000 ÷ $8,750,000 = 8.6%. Share of the company: 8.6% × 75% = about 6.4%.
6. Without a step-up: $500,000 ÷ $8,500,000 = 5.9% of the pool, or about 4.4% of the company.
7. The step-up moves about 2 percentage points of the company from new-money investors to search investors.

Self-funded search

1. Investors put $50,000 at risk before closing to fund deal costs.
2. Step-up at 2x: $50,000 × 2 = $100,000 of credit.
3. Other investors put in $400,000 at closing. Total investor credit: $500,000.
4. Early investors' share of the investor pool: $100,000 ÷ $500,000 = 20%.
5. At 1x they would hold $50,000 ÷ $450,000 = 11.1%. At the older 3x they would hold $150,000 ÷ $550,000 = 27.3%.

In the first case, the $500,000 was spent on the search, so the deal receives only the $8,000,000 of new money. In the second, the $50,000 paid deal costs and $400,000 arrives at closing. The step-up changes who owns what, not how much money is in the company.

What should you check in a step-up term sheet?

• Which dollars step up. Search capital, deal-expense capital or both. Money invested at closing usually does not.
• Whether the preferred return and liquidation preference follow the credit or the cash. On $50,000 at 2x, that is a preferred return on $100,000 versus $50,000. The difference compounds over the life of the deal.
• Who is diluted. Usually later investors. Confirm whether the searcher's percentage is fixed or diluted too.
• What happens if the deal changes. If the first deal dies and the same money funds a second attempt, does the step-up still apply?
• How it converts later. If the company ever moves under a holding company or lists, stepped-up preferred equity usually has to convert to common or parent shares. Write that mechanism into the terms and confirm it with securities counsel.

One more point for SBA deals. The lender counts cash, not credit. The cash in your 10% equity injection must be real money, seasoned in an account for about 30 days or documented as to source. A step-up credit does nothing for the injection.

Where these numbers come from: Traditional search budgets, the 150% step-up and searcher equity come from Long Angle. The self-funded 2x step-up comes from Smash and Searchfunder. The acquisition rate comes from the 2026 Stanford Search Fund Study. The QoE requirement and injection rules come from SOP 50 10 8.1 as summarized by Beancount, and QoE pricing from Searchfunder. SOP 50 10 8.1 applies to loans numbered on or after October 1, 2026; lender practice under it is still settling and these are secondary summaries, so confirm current terms with your SBA lender.

Related questions

Is a step-up the same as a discount?

In effect, yes. A 2x step-up is the same as buying the deal security at half price. A 150% step-up is the same as paying about 67 cents per dollar of credit.

What happens to a step-up if the deal fails?

Nothing converts, because there is no deal to convert into. The money spent on the search or on diligence is gone. That loss is the risk the step-up pays for.

Do I have to offer a step-up?

No. It is a market term, not a rule. But investors who take pre-closing risk without one are getting the same price as investors who took none, and you should expect them to ask for it.

What comes next

A step-up decides who owns what. The order in which cash is paid out is the next question: How does the waterfall and preferred return work in a self-funded deal?

Related articles

• What are standard investor terms for a self-funded search?
• How does the waterfall and preferred return work in a self-funded deal?
• What are typical independent sponsor fees and carry?
• Traditional search fund or self-funded search: which is right for me?
• How do you build a holding company for acquisitions?

Meraki Dealmakers is a service of Meraki Partners, LLC, an advisory firm. It is not a broker-dealer, investment adviser, business broker, law firm or accounting firm. This article is general information, not legal, tax or investment advice.