Pricing Strategy and Acquisition Financing

Posted on: July 15th, 2023

acquisition-financing

Giving the roaring inflation of the last two years, pricing strategy has become a huge issue for every business in the United States. This is especially true for borrowers of acquisition financing. Prior to this inflationary outbreak, most business owners had a relatively relaxed pricing approach. Acquisition financing lenders paid scant attention as to how their borrowers would optimize pricing. While private equity firms had long used pricing as a key lever in generating financial overperformance, most middle market businesses continued to use their historical pricing approaches, even during economic downturns.

Years of abundant labor, cheap imports and low interest rates had created price equilibrium for most businesses. The sudden onset of inflation in 2022 has caused a seismic shift in how business owners focus on pricing. Two types of inflation were unleashed recently – demand pull and cost push. Demand pull was triggered during the supply chain dislocation where demand for hard goods exceeded supply. Cost push has been triggered due to the rise in raw material costs across the purchasing spectrum. Acquisition financing lenders have seen firsthand their portfolio companies struggle to pass through costs. While some business owners pivoted and passed through cost quickly, others were slower to pass through due to contractual terms or lack of rising cost visibility.

Many companies, reticent to raise prices during good times, have been surprised at the ease of pass through. While this pass through is economically justified due to the rising cost environment, it also has led to a pricing optimization focus amongst acquisition financing providers and their borrowers. Companies are now more likely to innovate ways to increase prices and to focus on parts of their businesses where they can justify premium pricing. Additionally, the rising cost of financing has naturally led borrowers to recalibrate their ROI across all products, services and divisions. Companies are now more focused than ever on pricing strategy, using it as a lever to increase profit and long-term value.

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.