Extra Time – The Key Component in Acquisition Financing

Posted on: October 7th, 2021

acquisition financing

Acquisition financing structures usually have several layers of different forms of capital. Most garden variety acquisition financing structures contain a blend of debt and equity capital. Within the debt capital stack, there can be one or more kinds of debt, ranging from bank loans to mezzanine loans.

Purveyors of acquisition financing are conditioned to differentiate their value- add based on price and value. The saying goes – we charge more because we lend deeper into the capital structure. In going down the risk spectrum, we require a higher risk adjusted return. This all makes logical sense, but most borrowers have little appreciation of the highly refined concept of lender risk spectrums. They buy and run businesses and generally don’t evaluate their acquisitions through this type of risk prism.

Challenges of Acquisition Financing

Most acquisition sponsors see integration risk and scale-up risk as their biggest challenges. They are uber-focused on executing the growth plan and taking the business to a higher level of performance. Smart acquirers make sure they have adequate capital for the scale-up at hand. For most, the unpredictability of the timescale is the biggest issue they will face. Extra time is always needed to achieve the desired growth objective.

Along the way companies encounter unforeseen obstacles such as delays in staffing up, new products, new systems, and new operational capacity. Having extra time for the scale up is critical to ensure that the company can turn things around and get back on track. Conservative time factors should be engineered into the acquisition financing debt structure, on the front end of the deal. This can be in the form of extended interest only periods, one-time principal holidays, and 100% back ended principal repayment.

Extra time gives the company operational flexibility to make the tough decisions and stay the course when the road gets bumpy. Acquisition financing lenders should emphasize the time-based value their structures provide. This is the real nuts and bolts benefit to the company dealing with operational uncertainty along their scale-up journey.

As the Fed decides to ease interest rates, middle market acquisition financing structures will benefit in a number of ways. The underlying values of middle market companies will increase leading to a higher enterprise value and lower loan to value ratios for existing portfolio companies of acquisition financing lenders.

The role of acquisition financing is infrequently elevated above a functional transactional one. When a business needs financing to acquire, they go to the market and source acquisition financing to supplement their equity investment to close the deal. Despite existing in many different forms, acquisition financing is rarely explained in terms of the value it brings to the acquirer.

Acquisition financing underwriting usually focuses on business and financial issues that underpin the stability of cash flow. Providers of acquisition financing usually validate the durability of a company’s competitive advantage and the depth of its resource base. Environmental issues are usually not a major part of the analysis in today’s service and technology-based economy.