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.

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.