Keys To Selecting The Right Debt Structure

Posted on: November 22nd, 2021

debt structure

As in most things in life, a few key decisions determine a lot. And so, it goes with the selection of a debt structure for your acquisition financing. Debt structure selection is paramount and has a large influence over the fate of your deal.

Debt Structure for Successful Deals

Successful deals use debt structures that provide incremental financing, extra time for performance and a collaborative lender relationship. Less successful deals include miserly financing proceeds, short repayment periods and highly transactional lenders. There are many debt structures each with their own underlying methodology, based on the lender’s view of risk.

Asset based structures are tightly framed to collateral values on a real time basis. This loan structure usually does not deliver enough financing for M&A and is primarily used for working capital support. Cash flow-based debt structures are framed to the future cash flow value of the company. This results in larger loan sizes and much longer loan terms, resulting in a generous performance runway for an acquirer. Loans pegged to cash flow value are not backed by hard collateral and result in the need for the lender to be more collaborative with the borrower. When selecting a debt structure, there are 4 key variables to bear in mind:

De-risk your acquisition plan – acquisition risk in the form of integration risk is omnipresent. Having a longer term and more evolved debt structure can help de-risk your acquisition, by giving you more time and more liquidity to recover from surprises.
Initial Performance Counts – acquisitions that start strong usually end up being successful. Those that stumble out of the gate, usually limp for the remainder of their life. Ensuring that you can perform strongly out of the gate is important. The right debt structure can ensure this happens.
The Rule of 2X – often in deals, initial acquisition assumptions are wildly off-base. New investments and implementation periods often cost twice the initial amount and take twice as long. A quality debt structure is a valuable insurance policy to mitigate this risk.
It’s All About Capital Availability – in the end, most successful deal operators will tell you that the key to success is the amount of capital they had access to, not necessarily the price or the cost of the capital. Higher end debt structures deliver more proceeds and can even provide follow-on financing.

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.