Different Forms of Acquisition Financing

Posted on: July 12th, 2022

acquisition-financing

When going through an M&A transaction, companies have a pronounced need for finance but sometimes fail to realize they have a plethora of options. Acquisition Financing covers a broad range of finance structures. Lenders appreciate companies that are educated as to the various forms of acquisition financing, the parameters required, and financial performance needed to support their loan ask. Companies can truly differentiate themselves to the extent they engineer market understanding into the front end of their loan process.

Companies need to self-assess before embarking on lender engagement and understand how their combined financial size, post-acquisition will be perceived by the lending market. For example, a company under $5 million in revenue and under $1 million in EBITDA may look towards an SBA loan. However, if combined the two companies then make $10 million in revenue and $3 million in EBITDA, you have a middle market company on your hands. Middle market companies have more forms of acquisition financing to choose from. These options range from bank loans, mezzanine debt, unitranche debt or second lien debt. Each form of acquisition financing has a different set of pros and cons that a company should evaluate before deciding which lane to dedicate their time and resources to. For example, each form of acquisition financing provides different levels of financial flexibility, post-closing performance requirements and seniority.

Usually, a mix of these different forms of acquisition financing allows your company to grow and develop at the pace you are comfortable with. While senior debt is an important part of your acquisition financing strategy, these lenders have short term and rigid repayment dates. Mezzanine debt offers more flexible principal repayment and also provides structural flexibility to access capital at different periods of growth and scale-up when needed. The key to deciding the best form of acquisition financing is to map out your growth plan incorporating acquisition financing, growth capital and working capital for the next 3 years. The total level of funding needed will dictate the proper structure to power your acquisition growth.

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.