Non-Linear Performance and Acquisition Financing

Posted on: April 25th, 2024

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During their underwriting processes, acquisition financing providers analyze probable performance projections for their proposed borrowers. The underwriter often toggles between a few scenarios to sensitize the growth variables leading to slower revenue and margin growth over time. The lender’s underwriting view is usually an extension of its credit intelligence and historical experience.

Navigating Non-Linear Business Performance in Acquisition Financing

The financial projections, always heading in an upward direction, lead the acquisition financing provider to anchor their assumption-setting around the sustainability of growth rates embedded in the model. It is as if the performance projection itself regulates the boundaries of the lender’s downside sensitivity scenario. 10% projected revenue growth is usually discounted to 6% or 7.5% by the acquisition financing lender. 2% projected growth in gross margin levels usually gets discounted to 1% growth. The acquisition financing lender usually relativizes its assumption using the company’s numbers as a baseline. This smooth discounting approach belies the reality of business performance which inordinately occurs in a non-linear manner.

Well-managed companies, regardless of the clarity of their crystal ball, always have a bolt out of the blue event whether it be a customer loss or an industry shift that was totally unplanned for. While inflation is all the rage now, there were hardly any companies factoring it into their growth projections in 2020 or 2021. Back in 2019, there were no companies factoring in the 2020 shut down of the economy into their numbers. The reality is that there are exogenous factors surrounding each business, also known as event risks, which play a bigger role in the ultimate performance trend. Acquisition financing providers that can conceptualize non-linear performance in their underwriting and post-closing portfolio management are the best lenders for a company to work with. Their grasp of the unpredictability of middle market business risk is a true differentiator amidst an industry populated by unoriginal thinkers.

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.