Acquisition Financing – A Hat Trick Of Enterprise Valuation Gain

Posted on: February 6th, 2022

acquisition-financing

Growth is the imprimatur of a successful company and is often the single most important variable in valuation. Acquisition financing figures prominently in unlocking a company’s growth rate. Investors and lenders need growth to generate returns, leading them to seek companies with large addressable markets and first mover status.

Often, the intention to grow is as important as the historical ability to grow. Companies can sustain extraordinary valuation altitude if their growth story is well articulated and credible. Acquisition financing allow companies to accelerate their scale-up by compressing 3 to 5 years of ordinary organic growth into one large growth step, in one fell swoop fashion.

Rapid Scaling Through Acquisition Financing

Instead of the slow and steady road, acquisition financing enables rapid scaling and enterprise valuation transformation. This allows a company to make exponential valuation gains due to the multiple effect afforded larger companies. Smaller middle market companies, especially those with less than $20 million in revenue and $2.0 million in EBITDA have a limited number of buyers because of the minimum check sizes of private equity and acquisition financing providers.

Larger companies, with EBITDA ranging from $5 to $10 million have a much deeper pool of buyers. It pays to grow through acquisition, as this type of growth brings multi-directional competitive advantages in the form of products, customers and resources in addition to ultimate valuation gains. With acquisitions, companies gain mass giving them more resources and diversification allowing for multi-market expansion and product differentiation.

Most importantly, as companies ascend the acquisition stairway, their valuation multiples grow disproportionately higher. Companies at $2 million of EBITDA may receive a 5-times multiple whereas companies at $5 million may receive 8 times multiple. Acquisition financing provides a hat trick of benefit – bigger EBITDA, shorter time horizon and higher ultimate exit valuation multiple.

As the Fed decides to ease interest rates, middle market acquisition financing structures will benefit in a number of ways. The underlying values of middle market companies will increase leading to a higher enterprise value and lower loan to value ratios for existing portfolio companies of acquisition financing lenders.

The role of acquisition financing is infrequently elevated above a functional transactional one. When a business needs financing to acquire, they go to the market and source acquisition financing to supplement their equity investment to close the deal. Despite existing in many different forms, acquisition financing is rarely explained in terms of the value it brings to the acquirer.

Acquisition financing underwriting usually focuses on business and financial issues that underpin the stability of cash flow. Providers of acquisition financing usually validate the durability of a company’s competitive advantage and the depth of its resource base. Environmental issues are usually not a major part of the analysis in today’s service and technology-based economy.