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.

As the Fed decides to ease interest rates, middle market acquisition financing structures will benefit in a number of ways. The underlying values of middle market companies will increase leading to a higher enterprise value and lower loan to value ratios for existing portfolio companies of acquisition financing lenders.

The role of acquisition financing is infrequently elevated above a functional transactional one. When a business needs financing to acquire, they go to the market and source acquisition financing to supplement their equity investment to close the deal. Despite existing in many different forms, acquisition financing is rarely explained in terms of the value it brings to the acquirer.

Acquisition financing underwriting usually focuses on business and financial issues that underpin the stability of cash flow. Providers of acquisition financing usually validate the durability of a company’s competitive advantage and the depth of its resource base. Environmental issues are usually not a major part of the analysis in today’s service and technology-based economy.