When Acquisition Financing Overstays its Welcome

Posted on: August 23rd, 2023

acquisition-financing

Like most things in life, there is a time and a place for acquisition financing. Embarking on an acquisition financing journey requires a company to extend beyond their local lender. Bank loans are not set up to fund transformational acquisition growth that can vastly increase the scale of your company. Acquisition financing, whether in the form of cash flow-based term loans, mezzanine loans or even C&I loans, is designed to bridge this gap and provide a strong runway for acquisition success during this transitional period. Acquisition financing loans are more expensive than bank loans due to the higher risk of an acquisition versus organic business growth, but they are well worth the incremental cost.

Without the larger ticket size provided by an acquisition financing loan, there is a huge opportunity cost as you simply cannot close the deal. Acquisition financing loans are essential to financing transitional growth steps, yet their benefits fade after the acquisition is integrated and significant profit growth is realized. At this point, the company emerges much larger and financially stronger and has greater capital options. While the acquisition financing lender wants to stay in a good deal as long as possible, the company is now beyond its transitional growth period and does not need to pay a premium for this acquisition financing loan. It is best to find a conventional bank lender to refinance the loan thereby reducing your cost of capital.

In some cases, where there is continued need for financing, such as follow on acquisitions or corporate investment, it is advisable to keep the original acquisition financing lender in as they will happily continue to fund new acquisitions and growth projects. Additionally, if there are some material changes in the business and subpar performance, an acquisition financing lender who has been in the deal for several years will likely be the better lender to deal with. The key is to ensure that you do not unnecessarily keep the higher cost acquisition financing lender longer than you must. As the company grows, its credit standing increases leading to higher quality, lower cost capital options to choose from.

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.