The Road to a Successful Acquisition

The road to a successful acquisition is a long and hard road. Signing the deal, conducting diligence, learning the operation and building relationships with management are just a few of the tasks. Typically, acquirors operate under an assumption that their deal is financeable, until they are turned down multiple times from lenders, and have to recalibrate. It’s always a smart idea to have a strong feeling of finance-ability on the front end of the transaction, before the lender engagement process even starts.

Most independent sponsors have some familiarity with the lending markets and understand the basic rules. Where they sometimes need help is in discerning the current market’s view of their deal. This includes industry risk, deal type risk and overall credit risk. Industry risk relates to the riskiness of the industry cycle and the level of recession resistance. This is always changing in an economy and requires market feedback to develop a big picture view.

Deal type risk relates to the transaction dynamics – is the owner cashing out 100% or is the owner scaling up. Deals where the owner is cashing out are viewed as inherently more risky than other deals. This too is fluid and colored by the level of dry powder in the market and the view of the credit cycle. Lender’s credit risk view means the lender’s assessment of the current and future financial performance of the company. Will earnings remain stable or will they decline in the future? Will the company have the wherewithal to curtail the loan amount, even if the going gets tough? Further compounding the credit risk view is the inherent differences in vantage points of different lenders.

Asset Based Lenders and Cash Flow Lenders

Asset based lenders and cash flow lenders diverge in their analytical approach for credit risk. Cash flow lenders are understandably EBITDA focused and try to create an underwriting case that accounts for future erosion in EBITDA levels. Asset based lenders, due to their collateralized position, are less focused on EBITDA and more focused on the various outcomes to the future value of their collateral given different economic scenarios.

How to Confirm the Finance Ability of your Business Deal

Finally, different types of lenders even within the cash flow or asset-based groups can have divergent views based due on their higher tolerance for credit risk. Given this, it pays for an independent sponsor to learn where the market is and take stock of the finance-ability of their deal, up-front. Here are the Attract Capital 4 ways to confirm the finance-ability of your deal.

Bring on a financing expert with deep industry knowledge – there is no substitute for getting an informed view from an expert who has closed many deals. A good advisor will not only give you their view of the finance-ability but will test it in the market with several of their lenders.
Spend time learning the credit markets– Investing hours researching will help you develop a baseline of the basic rules to be used. Call your local banker, accountant and lawyer to pick their brains. They may not know a lot about the credit markets, but may point you in the right direction.
Speak to active lenders in your space – within each vertical there are a few names of lenders that emerge. Get to know these people and ask them for advice.
Make sure the deal conforms to basic debt multiple rules – most cash flow lenders will not exceed 3 to 4 times cash flow. Asset based lenders are a bit more flexible. Both types of lenders will require strong equity sponsorship.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.