Long Term Acquisition Financing is the Answer

Posted on: January 19th, 2024

acquisition-financing

The internet is awash with lending platforms plugging a wide variety of loan types which can be used for acquisition financing. These platforms leverage the low-cost aggregating efficiency of the internet to build large portfolios quickly. These loans are usually pooled with other like-kind loans and then securitized. These loans are perfectly fine for small businesses to fund growth but generally inadequate for acquisition financing due to their reliance on asset collateral. These loans such as the SBA 7A loan are designed to fund commercial finance needs as opposed to corporate finance needs such as acquisitions and buyouts.

When used for acquisition financing, they often leave a funding gap between the total acquisition financing required and their loan proceeds. This leaves a small business between and betwixt, as their acquisition financing loan size is too small for a middle market lender, and they can only raise 50% to 75% of what they need from an SBA loan. This leaves them only a few options including short term acquisition financing, seller notes or investing their own equity to plug the gap. Some online lenders offer acquisition financing but is very different than middle market acquisition financing. The industry standard term for middle market acquisition financing loan from a bank or non-bank source is usually 5 to 6 years. This reflects the fact that the underlying risk of an acquisition is fundamentally a long term vs. a short-term risk.

The acquirer has to integrate the business first and then focus growth in a new direction. This usually occurs over the course of the first two to three years. Once this has been successfully implemented, the business then generates higher levels of cash flow used to repay the acquisition financing loans. Short term acquisition financing loans such as 12 months to 2-year term loans that are offered online, create performance pressure for the company to integrate and grow at warp speed. This causes a high rate of change for the business which can backfire and cause the business to hit the wall in a short period of time. The better option for the acquirer is to restructure the deal with a seller note and to bring in equity investment to allow the company to have a longer-term growth runway, leading to high quality, sustainable growth.

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.