The Tortured Acquisition Financing Department

Posted on: April 30th, 2024

acquisition-financing

As new acquisition financing credit funds pivot to non-private equity sponsored deals, many lack experience with the asset class. Non-sponsored deals such as direct loans to companies or loans to independent sponsors making acquisitions are quite different from private equity backed deals and require a different thought process and engagement style from the lender. The use of a PE focused lending practices on non-sponsored deal flow leads to inefficiency and a tortured acquisition financing department for the non-sponsored borrower. PE deal lending is essentially low risk, formulaic lending to companies owned by well-capitalized owners with significant capital to support the company.

Distinctive Acquisition Financing Perspectives: Private Equity vs. Non-PE Backed Deals

Acquisition financing lenders of private equity backed deals are essentially relying on the well-heeled private equity firm, who are usually investing 40% to 50% of the capital needed. They feel that if the company ever runs into trouble, the private equity firm will support the company due to their sizeable initial investment. Lenders usually focus their activities on a select group of PE firms, trying to become their house bank due to the implicit put of their future support. This view has relegated this type of loan to commodity status where the lender is merely dollars provided and price. On the other hand, non-PE backed deals are deals where the equity investor is not a deep pocketed investor but a person or a company, with limited equity capital. The lender may be the first institutional provider of capital to the company. The borrower needs a lender who can think differently about the risk of the deal as opposed to applying private equity credit tests.

The acquisition financing lender needs to be more open minded about the quality of the ownership. They need to see that that $1.5 million of equity invested from a person worth $10 million is worth materially more than a private equity fund investing $10 million out of a $200 million fund. They need to understand that this equity is not disadvantaged but rather higher quality because it comes from the person who will own and run the company. A more approachable and understanding style is needed as often the sponsors are first gen entrepreneurs. They are enormously skilled but unfamiliar with lending protocols. While less buttoned up than a private equity deal, these sponsors possess true grit and strong vision. Acquisition financing providers who grapple with these issues upfront and get the right people on their platform are poised for success in this area. They will make good loans and provide a non-tortured experience for non-sponsored borrowers.

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.