The Hidden Term Risk of Acquisition Financing

Posted on: January 25th, 2024

acquisition-financing

In the frenetic dealmaking arena of middle market acquisition financing, buyers are usually time pressured and under the gun to close. Often this results in the buyers changing course mid-capital raise and forgoing their preferred form of acquisition financing. As they get to the end of their letter of intent exclusivity period, they look for any type of acquisition financing as opposed to the best type of financing. This usually results in an inferior acquisition financing structure of higher cost and shorter term of 2 years or less. Despite being able to close, this approach is fraught with hidden term risk that can sink a deal due to the imposition of compressed execution timetables and scale-up operational steps.

Acquisition financing in the purest sense is a loan to acquire the assets or stock of a company by either an acquiring sponsor or company. Acquisitions involve intensive scale-up blueprint setting and post-closing integration. Often the acquired target is merged into another business which involves a tremendous amount of new process implementation and change management. Frequently the new process implementation encounters resistance and takes longer than originally estimated. Most acquisition financing deals take at least 6 months to complete initial integration steps and then an additional 12 to 18 months for the new process to take root and show results. The new way of doing things is often a shock to the system resulting in adoption lethargy and operational stress and underperformance. Smart buyers expect this and invest the necessary resources to ensure that any changeover to the new process happens swiftly and effectively.

Nonetheless, the conversion to the new process takes longer and usually requires more time and money to get right. When the acquisition financing matures in 18 months or even two years, it requires all integration and new process steps to be completed rapidly often within a 3-to-6-month timeframe. The need to move so rapidly can create chaos within the organization and result in employee turnover. There is a reason why the highest forms of acquisition financing such as a bank term loan or a mezzanine debt loan have 5-year terms. Inferior short term acquisition financing such as bridge financing injects too much hidden term risk into the integration equation. What the buyer gains in getting the deal closed, they give up in terms of foisting short term execution risk into their post-closing integration.

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.