Everything you need to know about acquisition finance
Acquisitions are a tried and tested method for accelerating business growth, enabling businesses to expand their market share and take advantage of synergies between their own offering and that of potential target businesses.
But how does a business fund an acquisition? That’s where acquisition finance comes in.
This article will explain types of acquisition finance, how acquisition finance works and why growth via M&A is a great option for ambitious businesses.
What is acquisition finance?
Acquisition finance refers to the funding used by a company or individual to purchase and acquire another business. It covers a wide variety of funding types, including bank loans, equity investment and debt, all which can be used to facilitate the purchase of another business.
How does acquisition finance work?
Once an acquisition target (the business to be purchased) has been identified and valued, acquisition finance can be raised for a corresponding amount.
Banks, alternative lenders and equity investors can all be sources of acquisition finance, but all will have different approaches to how they value the target business and what percentage of this value they will be willing to lend.
More specialist lenders that are experienced at supporting M&A activity, may be able to use the balance sheet and/or forecasted revenue of the target business as leverage for the acquisition finance. These specialist lenders are also more likely to support buy-and-build type strategies, where a business intends to make multiple acquisitions over a period of time – in these instances the lender might commit to lending a larger total sum, which is then drawn down in tranches as and when each of the acquisitions are executed.
Experience is a fundamental part of successful M&A and successful acquisition finance raises, so if that experience doesn’t already exist in-house (and even if it does!) it’s a good idea to work with advisors and lenders that will be familiar with your situation and can overcome any challenges before they arise.
The role of acquisition finance in business growth
In simple terms, it is the acquisition activity that accelerates growth but, in most cases, the acquisition finance that enables the acquisition activity.
Acquisitions empower businesses to expand operations, leverage synergies with the target business to improve efficiencies and increase market share, as well as access new technologies, intellectual property and talent.
For most businesses, it is acquisition finance which enables all of the above to happen, therefore accelerating growth in a tried and tested format.
There are many other growth benefits to mergers and acquisitions – read about them here.
What are the types of acquisition finance?
Acquisition finance is a broad term which covers multiple types of funding, each with their own pros and cons.
Bank loans
Bank loans are a common form of acquisition finance, providing upfront capital for purchasing another company. These loans offer a structured repayment plan based on cash flow projections and the acquiring company’s financial health.
Lenders typically assess factors like profit margins, balance sheet strength and collateral when evaluating loan applications for acquisitions. This can make bank loans a reliable and cost-effective method of financing acquisitions for more established organisations, but more challenging for those that are earlier in their growth journey.
Debt financing
Often a better option for less established and faster-growing businesses, similar to a bank loan, this approach involves borrowing funds to facilitate the acquisition of another company.
Debt finance can be structured in a variety of ways, however, making it more flexible, accessible and potentially affordable than conventional bank loans.
Specialist debt finance providers will also enable businesses to leverage the balance sheet of the target company to raise funds, unlocking a greater pool of capital than what they might raise from their own balance sheet alone.
Equity financing
Equity financing involves raising capital by selling shares of ownership in the company. This method does not require immediate repayment like a loan but does mean diluting the ownership stake in the business.
It is commonly used for startups and high-growth companies that may not have sufficient cash flows for debt repayment. Equity financing can offer flexibility in terms of repayment and can attract investors seeking long-term growth potential in the acquiring company.
Private investors
Private investors, including alternative lenders and private equity firms, are a common source of financing for acquisitions.
One advantage of working with private investors is their flexibility. Unlike traditional banks, private investors don’t have the same strict underwriting process, allowing for more customised financing solutions. Private investors can also structure their investment as equity in the new entity, providing ongoing support and guidance to the acquiring company.
Leveraged buyout
A leveraged buyout (LBO) is a common way to finance an acquisition, particularly for private equity firms. In an LBO, the acquiring company, usually a private equity firm, uses a significant amount of debt financing to fund the acquisition. The target company’s assets and cash flow are often used as collateral for the debt.
LBOs offer several advantages for both the acquiring company and the target company. For the acquiring company, it enables them to make a large acquisition without using a substantial amount of their own capital. The debt financing used in an LBO can be repaid using the cash flow generated by the target company’s.
For the target company, an LBO can provide access to additional resources and expertise from the private equity firm. The private equity firm can help drive growth and operational improvements, potentially increasing the value of the target company.
Management Buy–Out
A management buyout (MBO) is a type of acquisition financing where the existing management team of a company purchases the business from its current owners. MBOs are often used in cases where the current owners are looking to retire or exit the business.
MBOs can be an attractive option for both the management team and the current owners. For the management team, it enables them to take control of the company and continue its operations. It also provides an opportunity for the management team to benefit directly from the company’s future success.
For the current owners, an MBO can provide a smooth exit strategy and potentially allow them to retain a minority stake in the business. This can be beneficial if the current owners want to continue to have some involvement in the company’s operations or if they believe in the management team’s ability to drive future growth.
Financing an MBO can involve a mix of debt and equity financing. The management team may also contribute their own capital to the acquisition. The specific financing structure will depend on the size and complexity of the MBO.
Mezzanine financing
Mezzanine financing is a type of debt financing that sits between senior debt and equity financing in the capital structure. It is often used to fund acquisitions and leveraged buyouts.
Mezzanine financing is considered a subordinated debt, meaning it has a lower priority of repayment compared to senior debt. It is typically unsecured and carries a higher interest rate than senior debt. In exchange for the higher interest rate, mezzanine lenders may also receive equity warrants or other equity-like features.
Mezzanine financing can be an attractive option for companies looking to fund an acquisition because it allows them to increase their debt capacity without diluting ownership. It can also be a flexible financing option, as mezzanine lenders are often willing to provide financing based on the cash flow and growth potential of the acquiring company.
Asset-backed loans
Asset-backed loans are a type of financing where the loan is secured by specific assets of the borrowing company. These assets, which can include real estate, accounts receivable, inventory, or intellectual property, serve as collateral for the loan.
Asset-backed loans can be a viable option for companies looking to finance an acquisition, particularly if they have valuable assets that can be used as collateral. The loan amount is typically determined based on the value of the assets and the borrowing company’s ability to repay the loan.
One advantage of asset-backed loans is that they often have more flexible covenants compared to other types of financing. This can provide companies with greater flexibility in managing their finances post-acquisition.
The process of securing acquisition finance
Preparing your application
Lenders will typically ask for financial statements, including income statements, balance sheets, and cash flow statements. These documents provide the lender with a snapshot of the business’s financial health and its ability to generate cash flow.
Lenders will also evaluate the business’s creditworthiness, considering factors such as its payment history and credit score. Additionally, lenders may conduct underwriting, which involves assessing the risks associated with the acquisition and determining appropriate terms and conditions for the financing.
It is crucial to ensure that your application is complete, accurate and well-prepared to increase your chances of securing acquisition finance and the speed with which you can access capital.
Looking for a lender
When it comes to financing acquisitions, the right lender is really important – M&A can be complex enough as it is, so having a lender that understands the process and has experience at providing acquisition finance can make a big difference.
Look for lenders that have a track record of successfully supporting businesses in acquiring other companies. It is also important to consider the lender’s terms and conditions, including interest rates and repayment terms.
Additionally, consider whether the lender offers additional services, such as lines of credit or follow-on funding that can support your business’s growth beyond the initial acquisition.
Pulling the trigger
Find out more about executing a successful acquisition here.
If you are interested in growing your business via an M&A strategy, get in touch with one of our lending experts who will be more than happy to discuss our funding options, whether we’re a good fit to support your goals and what the next steps would be.
