The True Cost of Acquisition Financing

With middle market acquisition financing, cost measurement is anything but a simple calculation. Most rookie buyers approach loan pricing as if all loan structures are the same and provide comparable value. Like an apple is to an orange, the bank loan is to the mezzanine loan, especially in an acquisition financing loan structure.

Mezzanine loans are usually much larger sized loans than bank loans, and much longer dated with respect to repayment and maturity. While most banks live in a governmentally regulated environment of minimal risk assumption, mezzanine lenders are not regulated and live a little on the wild side. They will assume risk and will base their ultimate principal repayment on the growth of the company’s cash flow.

Mezzanine Debt as an ideal form of Acquisition Financing

Mezzanine debt makes an ideal form of acquisition financing for this very reason. While mezzanine debt cost of 10 to 12% is certainly higher than a bank loan of 4% to 5%, it has far greater utility to the buyer, in the form of more capital and more time. So, on a value adjusted basis, it is certainly possible to make the case that mezzanine debt has greater value, and thereby costs less in the overall scheme of things than a bank loan.

As the saying goes, you get what you pay for. When one lender will give you half of your entire capital need, but only charge you 4% you still cannot close the deal, so your opportunity cost is huge. The other lender will give you 100% of your capital need, thereby allowing you to close which eliminates any opportunity cost. The avoidance of opportunity cost in the mezzanine-based acquisition financing scenario is a glorious win for the buyer.

Acquisition Financing Providers

In addition, intelligent providers of acquisition financing also realize the company needs growth capital to power its scale-up post-closing. These lenders will also provide working capital and strategic capital to invest in the business to ensure the growth can be achieved. This may involve higher pricing than 10% to 12% or a small equity warrant.

Yet this additional growth capital can create a significant amount of value in the form of scale-up acceleration, thereby more than paying for itself. The key costing question with acquisition financing is not how much does the money cost, but what can be done with the financing. If it will fund your entire capital need at close and unlock higher rates of growth, it is providing very high value, at a very low cost.