Three Cardinal Rules when Acquisition Financing

Posted on: November 26th, 2020

cardinal rules for acquisition financing The post-Covid acquisition market is springing back to life. Many new buyers are eager to rush in and acquire companies with roll-up strategies in mind. The allure of a roll-up is tempting, and thematically most buyers think they can engineer one. Often buyers, in their zeal to acquire, forget a few of the cardinal rules when acquisition financing. In fact, many buyers need to slow down and think about these points before they get started even talking to lenders about their acquisition financing. These cardinal rules will help you clarify your deal objectives and your long-term goals.

Cardinal Rules for Acquisition Financing

Cardinal Rule #1 – Do you know anything about the business you are seeking acquisition financing for? It sounds a bit unreal but many buyers, particularly young buyers, often look to acquire businesses they have no experience with. They may have worked at higher levels of business such as consulting and investment banking so they may have a passing familiarity with the industry. But they lack direct experience and knowledge in the businessyet feel their skill set is strong enough to allow them to create value in an industry they know nothing about. While this type of thinking is mandatory in the technology world, where visionaries are creating new products and market, it is not viewed as a positive in acquisition financing roll-up world. Acquisition financing lenders like to know the people they are going to back have direct experience and know how to run a business.

Cardinal Rule #2 – Do you have equity money to put into the deal? Often buyers claim they want to see how much acquisition financing debt they can raise to solve for equity they need. Usually, these folks have no equity behind them. When you ask for your debt before you raise your equity, you look weak. Strong buyers have their own money or a close investors money behind them. This provides a level of seriousness to a lender and is a signal that others believe in your abilities. Most acquisition financing lenders understand that as an independent sponsor, you do not have a large fund behind you. But they still like to see you have equity money circled up before you get to them, to build your credibility in their eyes.

Cardinal Rule #3 – Do you have the deal signed up? It would appear illogical for an independent buyer to spend inordinate amounts of time on a deal they do not have signed up. Yet, many so-called buyers, not only do not have the deal signed up via a letter of intent, in some cases they have not even communicated with the target company or the seller. Acquiring companies is a complex process, but it all starts with a motivated seller and a motivated buyer entering into a buy-sell agreement to get the ball rolling. Without a solid LOI in place, you really have nothing to talk about with an acquisition financing lender.

While these cardinal rules may sound elementary, spending time addressing them will help you immensely in the acquisition financing arena.

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.