The Best Approach to Acquisition Financing

Acquirers can use any form of capital to fund a deal including bank loans, balance sheet cash, equity investment or seller notes when lining up acquisition financing. A combination of these in a bespoke structure provides an effective acquisition financing package. Usually, the inherent features of each form are analyzed, its cost, term, and covenants to determine its attractiveness leading to the final sizing allocation.

While this level of scrutiny is important it often overshadows the more important capital allocation decision – how much acquisition financing should be raised. Precision structuring of capital layers should not come at the expense of precision determination of the right level of acquisition financing to raise. When acquiring a company, growth capital is essential to ensure faster scale-up in new strategic directions. This new growth takes investment, time to mature and the right resources.

Things to note in Acquisition Financing

It is too important to the overall success of the deal, not to be funded as part of the acquisition financing.  Buyers often think they can push this growth capital investment off at closing and fund it out of future cash flow. This is a risky move to make. Given the high prices being paid in the middle market, the overall success of an investment usually depends on its post-closing growth and whether the business can scale to a size where it will receive a more favorable valuation. This multiple arbitrage investment theorem is a sound one but only when the buyer has a disciplined approach to including scale-up capital in their acquisition financing.

Even though raising 10% more acquisition financing at closing will be more expensive, it will generate superior returns in the form of higher growth. The opportunity cost of not having this extra capital is prohibitive as it usually leads to a subpar return outcome. Why go through the effort and trouble of acquiring a company and not position it for success with the right amount acquisition financing? Over long period of times, it is the quantity of capital not the cost of capital, that determines success. Pre-funding growth capital as part of an acquisition financing structure is the best approach.