Nailing the Right Amount of Acquisition Financing

Posted on: January 18th, 2024

acquisition-financing

In the middle market, independent sponsors rightly focus on the sources and uses of acquisition financing. At times they overfocus on this aspect to the exclusion of a more critical analysis, analyzing the true amount of acquisition financing needed to invest in and grow the business. All acquired businesses need investment to grow according to the vision of the acquiring sponsor. This extra amount of growth capital is essential to the long-term success of the deal and should be included in the amount of acquisition financing raised upfront to close the deal.

This additional layer of growth capital is in addition to any budgeted availability under a line of credit earmarked for working capital support. This extra layer of capital is best conceived as an infusion of high-octane venture capital that will allow the business to grow in ways previously unattainable. This can be capital for staff expansion, capacity expansion, new product launch or even investment in better technology systems. Acquisition financing providers are long term lenders and understand the need to invest in the business to activate growth. As long as the extra growth capital is a reasonable percentage of the overall debt facility and aligns with their underwriting criteria, they will provide it.

For example, $10 million for the acquisition and $2 million in growth capital results in a total acquisition financing round of $12 million. As long as the total debt to EBITDA is below 3.5 times and a strong return on investment case can be made for the growth capital, the acquisition financing provider will be onboard. Nailing the right amount of acquisition financing to not only buy the business but catalyze growth, shows higher level thinking on the part of the acquiring sponsor, and will attract a high-quality capital provider. In middle market deals, it is always the amount of capital a business has available as opposed to the price of the capital that makes or breaks the deal.

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.