Acquisition Financing Overview in the Post Covid Lending Market

Posted on: September 11th, 2020

Acquisition Financing Overview in the Post Covid Lending Market The market has recovered from the near shutdown from the Covid dislocation. Spreads had backed up 150 to 200 basis points for larger middle market deals but have now returned to normal spreads. Banks are very conservative and have tightened their credit screens. The economic panic and the need to put out PPP money so quickly, created anxiety in the banking community and many shut off lending for a 60 to 90 days to all but highly qualified, existing clients.

Private equity deal flow began to sputter in April through June due to the uncertainty in the market. Due to the nascent economic recovery, and the stabilization efforts of the Fed, the debt markets have improved. Debt funds are now aggressively looking for acquisition financing deals, and loan to value percentages have moved back into a normal range.

Acquisition Financing Range

For larger deals, EBITDA greater than $15 million, acquisition financing LTV’s can range up to 72%. The senior debt portion of the acquisition financing structure usually ranges from 50% to 60% with the remaining portion consisting of second lien debt or mezzanine debt.

In some instances, depending on the risk level of the deal and the acquisition financing lender’s view of the industry, structured equity may also be needed as part of the overall structure.

Acquisition Financing Metrics

The acquisition financing LTV metrics can also be expressed in a debt to EBITDA multiple. Straight debt, without any return kicker, is usually up to 5 times for larger middle market deals.

The ability to use general debt multiple ranges across a wide cross section of unique deals is more challenging now more than ever.

Middle market performance volatility was underscored in a dramatic way during the covid crisis. There were clear winners and clear losers that defied previous credit scoring generalizations.

Non-bank debt funds are anticipating a pick-up in volume in the remaining months of 2020 and into 2021 for a variety of reasons. Banks have pulled back and are less aggressive.

Private equity funds have enormous cash reserves and will need to put money to work at a faster pace.

Sellers that pulled back in the first half of 2020, will likely want to re-enter the market and cash out.

Finally, animal spirits and business confidence are reviving in the economy. All these factors should lead to increased M&A activity and near-term growth in acquisition financing activity.

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.