The Collision between Acquisition Financing Expectations and Post-closing performance

Posted on: November 10th, 2023

acquisition-financing

Ambitious roll-up acquirers rightly focus on acquisition financing availability in order drive their speed of their acquisition growth strategy. At early stages, they set an acquisition pace tantamount to multiple deals representing a large quantity of acquired revenue in a year. Acquisition financing is the fuel that funds their scale-up, as the prices paid usually far exceed their ability to fund internally. The need to grow quickly is embodied in the DNA of every roll-up sponsor in the history of middle market corporate finance.

Yet, sometimes due to the rate of acquiring and the intensity of operational focus, sponsors lose track of the importance of post-closing performance. Multiple deals can easily underperform relative to their pre-closing acquisition financing lender expectations. This usually manifests a due diligence oversight or operational integration lapse on the part of the buyer. Due to the fast pace of acquiring, this lapse, whatever its root cause, permeates each deal closed. This leads to a collision between acquisition financing expectations and post-closing performance.

How Acquisition Financing Lenders Work

When things move too fast, problems tend not to be isolated unto one deal, but get embedded across the entire portfolio, creating a major earnings headache for the buyer and the lender. This causes the acquisition financing lender to slow down and restrict future funding until problems are solved and the Company resets to a profitable course. The slowdown feedback is anathema to the roll-up sponsor who sees strategic considerations as paramount and financial underperformance as fleeting and secondary. When this happens, the sponsor has a few choices. They can slow down, maintain speed and find a new lender, or mediate a short-term turnaround plan with the lender that will unlock capital more gradually.

Each of these options are legitimate avenues for the sponsor with the best course depending on industry forces and operational turnaround probability. If the industry is in an advanced stage of consolidation and the window is shutting, it may be best to find a new lender and fix the operational problems simultaneously. If the industry is in an early stage of consolidation and the sponsor has time, it may be best to slow down and ensure that you have the right operational resources in place before you resume your acquisition growth. The right decision depends on each specific situation and requires careful consideration of the acquisition financing lender’s feedback.

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.