How much equity do I need to finance this?

Acquisition financing is a term that describes any type of capital used in the context of a business acquisition. It can be a bank loan, a cash flow loan, asset based loan or any type of equity instrument. When approaching how to finance an acquisition, businesses tend to struggle between how much equity and how large a loan they can get.

Many take a pragmatic approach and design a capital stack based on what they can get their hands on. Others take a deep dive into different debt vs. equity approaches, and analyze the implications of each. The information sources available to these folks are limited, with most businesses tapping their accounting or legal advisors for knowledge or contacts.

The best way to figure this out is to undertake a two-step analysis, first on the acquirer and secondly on the combination of both companies together. Only by assessing the valuation and debt capacity of the acquirer, can you have an informed view of the combined company debt capacity, and loan options.

The valuation of an acquirer is what they would be worth if they were to be sold today, based on current market conditions. This number varies based on the industry and size of the company but most middle market companies range in valuation from 5 times EBITDA to 8 times EBITDA.

If a company has $3 million in EBITDA and is valued at 5 times, then it has a theoretical equity value of $15 million. If the company has outstanding loans, these would be subtracted from the theoretical equity value to give you a net equity value. If this company has $10 million in loans, then it has a net equity value of $5 million.

This is very important to identify before starting your acquisition financing search, because this means that when you present the combined company to the lender, you have $5 million of equity value. While it is not cash equity, but rollover equity, you are putting this rollover equity into the deal.

In doing so, you are putting the value of your company at risk. Depending on the size of the loan needed and the the acquisition, many lenders will not require additional investment from you, and provide 100% of the cash needed for the acquisition.

If the loan request is large relative to the implied equity value, they may require some additional equity investment from your side. The key figuring out how much equity investment you need to finance your deal comes down to:

1. Understand the lending criteria – lenders look holistically at the equity rollover as well as the purchase price and purchase structure, when deciding how much they will lend.
2. Identify the right lender – some acquisition lenders prefer non sponsored acquisition, where others prefer direct lending opportunities to companies.
3. Consider the acquisition scale – if the company you are acquiring is larger than your company, the lender will likely not be able to do a high percentage of financing.
4. Make a sharp presentation – lenders prefer to deal with highly professional and well-presented companies. Make sure your confidential information memorandum is top rate and that you numbers are audited.