How to De-risk your Acquisition Financing

Posted on: January 22nd, 2023

acquisition-financing

Acquisition financing is debt capital used to fund the purchase of a business, whether by a private equity firm, an independent sponsor or a strategic buyer. Regardless of the buyer, acquisition financing provides the majority of funding required for the deal to close. Due to the various lending models used to fund acquisitions, loan structures vary as to pricing, amortization, term, security and covenants, and are highly dependent on the credit risk of the deal.

Evaluating Acquisition Financing

Most lenders have refined approaches to evaluating the risk of the acquisition financing and can easily discern if it fits their credit screen. Borrowers, on the other hand, once they receive interest from the lender, usually only negotiate the main points of pricing and terms of the proposed acquisition financing. They often sidestep a deeper strategic analysis of the loan and miss a golden opportunity to de-risk. By envisioning future outcome volatility and applying these scenarios to the loan, all companies can build stronger acquisition financing loan structures. For example, most companies underperform at some point, and the downturn can be more severe than expected. Ensuring you have extra capital on hand through requesting the lender to carve out line of credit availability up front, gives you extra capital in the tank.

Alternatively, you can just request a larger loan up front as part of the initial ask, to ensure you are rainy day ready. Often integration takes longer and results in the deferral of EBITDA growth, creating a steep cliff of principal repayment a year or two early. By asking your acquisition financing provider for a 100% interest only loan period, with the option to prepay principal, you give yourself complete repayment flexibility and avoid a sudden repayment cliff.

Additionally, most acquisition financing lenders have complete flexibility to sell or assign the loan throughout the term. This can mean that the loan ends up in the wrong hands, making life extremely difficult for the borrower. By having consent rights over who the lender can assign the loan, you protect yourself and make sure this does not happen. By integrating a range of outcomes into your front end structure, you create a more robust and protected relationship with your lender capable of surviving the stiffest of stress tests.

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.