How Fast Is Too Fast for An Acquisition Financing Roll-Up

Posted on: August 27th, 2022

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Looking to expand your company through an acquisition financing roll-up and need help creating a plan that will help the expansion get funded? First you need to think from a lender’s perspective as well as an owner’s perspective, and not one or the other. This means taking a step back from the grandiose plans for the company and examining your current company and its ability to take on other existing companies. The most important aspect of a roll-up is the basis upon which the future company will be built around.

Like the scaffolding of a building, your existing company should be a solid foundation that can support itself before taking on more weight. A successful starting company will show lenders there is good management and growth plans in place that will translate well to a larger scale and the resource bandwidth needed to keep the company from falling apart at the seams. A sensible speed to consider is to increase the size of the company 3-fold over a 5-year period. This represents a 25% annual growth rate. If you choose to grow at a significantly faster rate, the deal may become too risky for the lender and become more of an equity investor deal. Acquisition financing will be challenging to raise if your company is too small, lacks resources, or is currently under performing.

Once you have a solid foundation, good performance, and a reasonable number of acquisitions, a lender will take the deal seriously. Most roll-ups plan 2-4 add on acquisitions per year. The success of these acquisitions will determine your company’s future ability to obtain acquisition financing. Most lenders look to make sure each acquisition was successful and that the sum of the parts is greater than the whole before committing more funding. Without strong revenue and profit growth, there is little upside which could cause lenders to speculate there is a problem with the business model and acquisition strategy. Each deal in a roll-up is immensely time consuming and takes a lot of energy to transition.

Financing a roll-up can be extremely risky for a lender due to the inherent risks in merging any number of companies and unproven ability for management to succeed in an exponentially larger and more complex enterprise. Acquisition financing lenders will question your company and your management in greater detail than lenders for other loans. It is important to respect the lenders doing their job and understand the risks they must take on when entering into an agreement. The way management presents themselves may have as much to do with obtaining a loan as the success of their company.

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.