The Different Acquisition Financing Scale up Routes

Middle market companies have options with respect to their scale up routes. Unlike small businesses with less than $5 million in revenue, middle market companies have an entire funding market dedicated to their capital needs. The middle market funding ecosystem has many different segments with each segment representing a different approach to a funding solution. Acquisition financing is the most common transaction type and can enable dynamic scale up growth. The key to doing this is in selecting the right type of acquisition to maximize your scale up growth.

There are three separate types of acquisitions – strategic, organic, and transformative. Strategic is the most popular and involves acquiring a company for the product or customer synergy to be gained. This applies to companies expanding their network, enlarging their product line, or increasing their customer base or distribution channel. Any acquisition that enhances the existing resource footprint of the acquiring company thereby providing greater depth and specialization is a strategic one. These deals allow an acquirer to build value at an accelerated rate, when compared to the amount of time organic growth would take. The addition of product, customer, market depth brings more differentiating layers to the combined company, increasing its probability for sustained break-away growth.

Organic acquisitions are usually more targeted than strategic deals, in that they involve smaller scale purchases of discrete assets such as a customer list, a product line or IP. With these, the acquirer is not absorbing the whole company but digesting the acquired asset into their existing operation with a view toward enhanced monetization of the asset. A company with a wide product line can more fully monetize a newly acquired customer list. These deals allow a company to grow within their existing resource footprint but at an accelerated growth rate.

Transformative acquisitions are when a smaller company purchases a larger business, such as a business-to-business purchase or an independent sponsor buy-out. These acquisitions completely transform the business focus of the acquirer by dint of the size of the acquired company relative to the buyer. This type of deal provides instant scale-up velocity as the size of the resulting company is several times larger than the acquirer. These deals usually provide a platform-like level of value to the acquirer, giving them the ability to drive strategic or organic, add-on acquisitions later.

Understanding the Types of Acquisition Financing

Central to all types of acquisition financing is the reliability and flexibility of the acquisition financing lender. Banks provide acquisition financing but usually require a personal guaranty and have annual principal repayment. Their approach tends to be more rigid and less reliable than other more, cash-flow based lenders. Unitranche lenders and mezzanine lenders are highly flexible and provide bespoke structures. Their loan structures are designed around the cash flow valuation and growth capital needs of the company. In all transaction structure design, acquirers must align the business risk of the acquisition with the financial risk inherent to the transaction. More risky deals require a more supportive and patient lender. Less risky deals that pose little business risk are perfectly suited for less patient lenders such as banks.