Higher Level Thinking in Acquisition Financing

Posted on: June 29th, 2022

acquisition-financing

Acquisition financing is treated as a means to an end by independent sponsors. Most acquirers consider the acquisition financing process a run of the mill work stream. They need capital to close and believe the act of finding capital sources is the gateway to success. While connecting with the right type of acquisition financing lenders is necessary, there are other important issues that independent sponsors should be thinking about such as deal fit, asset quality and growth plans. These require higher level thinking on the front end.

Independent sponsors that spend time figuring out these critical elements will have a strong command of the fundamental underpinnings of their deal and be able to logically persuade lenders. Deal fit refers to the alignment of the purchaser’s background with the type of company they are buying. Often, sponsors jump into industries they have little experience with and expect acquisition financing lenders to trust their general management acumen in transforming the company.

Smart sponsors have deep industry experience and realize that they will have a much greater probability of closing success to the extent they stick to their industry knitting. Asset quality refers to the strength of the company being acquired. There is a tendency to overlook the fundamental quality of each company. Independent sponsors often see each company as equal to peer companies of same size and profit level. This is not the case as each company is unique and has different levels of product quality, system efficiency and management quality. Smart sponsors understand this and go to great lengths to understand each business through the eyes of an industry operator wherein they gain a birds-eye view.

Finally, acquisition financing lenders require EBITDA growth post-closing and consequently focus on the sponsor’s growth plan for the newly acquired company. The growth plan should be well researched based on grounded assumptions and incremental, as opposed to a radical, change for the business. Higher level thinking sponsors will select specific companies due to their ability to confidently implement a growth plan. Rather then rely on theoretical abstractions of growth, they know exactly what they want to do and how to do it. Smart sponsors get down in the grass roots of their acquisitions and make sure the deal fit, asset strength, management quality and growth plans are all in place.

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.