The Perpetual Motion Machine of Acquisition Financing

Posted on: January 17th, 2024

acquisition-financing

The quality of acquisition financing is a key factor in the overall success of the acquisition strategy. Roll-ups thrive when supported by a flexible and scalable acquisition financing solution. In many consolidations plays, roll-ups are participating in a land grab industry consolidation phase where time is of the essence and 6 to 12 targets may be closed in a 12-month period. This high frequency activity requires an acquisition financing lender to be well integrated into the capital supply line of the business.

Accordion Delayed Draw Term Loans are used in these situations to allow the acquirer continuous capital supply from the lender for future deal closings. It works in a fluid manner where the debt capacity of the business is continually growing and being utilized to fund new deals. As the Company EBITDA increases, it drives down its leverage multiple thereby earning more debt capacity that is subsequently used for the next deal. As long as there is additional acquisition financing capacity in the form of the delayed draw term loan, and the combined debt to EBITDA ratio is beneath the starting leverage ratio, the borrower can access additional acquisition financing. This creates a frictionless, perpetual motion machine for the roll-up acquirer through simultaneous debt capacity expansion and utilization around a fixed leverage ratio point.

For example, if the deal starts at 3.5 times leverage ratio, and reduces to 3.0 times at the end of year 1, the company can re-borrow up the original leverage multiple on the combined EBITDA including the new acquisition. This approach is debt-centric and has been used by many entrepreneurs to bootstrap their growth and amplify their equity stakes. When a roll-up company can add large layers of EBITDA with one acquisition financing lender, as opposed to having to swap out acquisition financing lenders, it is hugely beneficial and return catalyzing. Companies using this approach have grown from $1 million EBITDA to $10+ million of EBITDA with corresponding equity values increasing from $5 million to $100 million+. When you have a frictionless, perpetual motion powering your roll-up, significant growth runs are the rule, not the exception.

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.