4 minute read
Financing business acquisitions How ambitious regional businesses can fast track their expansion
By Nick Williams and Mark Diamond of DMH Stallard LLP
One of the striking features of the period since the Covid pandemic took hold is that M&A activity involving regional businesses has remained strong in the South East. Many businesses have managed to adapt to the changing business environment and 2022 sees them continuing to look for opportunities to make business acquisitions.
1WHY BUY A BUSINESS? Acquiring another business can provide immediate access to a market or build a market presence. The acquisition may result in economies of scale for the combined business, and in certain cases an acquisition can be a means of eliminating competition. An acquisition strategy enables a business to grow more quickly than it might do organically. 2 HOW WILL THE ACQUISITION BE PAID FOR? Some buyers are in the happy position of having sufficient cash to fund a business acquisition. This may be achieved by a single payment on completion of the acquisition, or by partly deferring part of the cash payment, the amount of which is often dependant on the future profitability of the acquired business (known as an earn out). In other circumstances, the seller or sellers may wish to have a continuing interest in the business sold, in which case they may accept payment by way of the issue of shares (equity) in a buyer company in part payment, or full payment in the case of a merger of the businesses.
If the buyer is a listed company, then a seller of a business is likely to be more willing to accept the buyer’s shares as payment, as they can be traded on a stock exchange.
3DEBT FUNDING Both listed and private companies may need or prefer to fund an acquisition by taking on debt. This can be attractive as it avoids the dilution of the equity in a buyer company and may be a relatively cheap way of raising money while interest rates are low.
There are many different types of borrowing available:
Senior Debt: a well established and profitable business may be able to obtain a secured term loan, which would take priority over other unsecured or junior debt. Such a loan is likely to have a relatively short term (up to five years) and may have a fixed or variable interest rate.
Mezzanine Debt: specialist lenders will provide mezzanine debt, which is a loan that can be converted into shares in the borrowing buyer company in certain cases, including the buyer’s default. There is a great deal of flexibility as to the way it can be structured.
Asset Based Lending (ABL): the assets of the target business as well as of the buyer can in certain cases be used as collateral for a loan, and these can include property, plant and machinery, other fixed assets, and inventory and receivables.
Bonds: these are debt instruments providing for repayment of the amount borrowed at a future date and the payment of interest on the amount borrowed. As these can be technically complex to issue, they are usually issued in tradeable form by large companies to raise significant amounts. The above methods in various forms can be used to finance acquisitions by one business of another or management buy-outs or buy-ins, where the management acquire a company or its business from the owners by using third party funding, in some cases private equity funds which typically make an equity investment.
The use of third party debt can increase the complexity and timetable of an acquisition, and buyers must expect the lenders to require access to the due diligence carried out on the target business and to carry out their own due diligence on the buyer.
4STRUCTURING THE ACQUISITION FINANCING It is important that the financing for the acquisition is carefully structured to align with the nature of the transaction, the buyer’s plans for the combined business and its ability to service the debt that is assumed going forward.
Although the costs of debt finance are often preferred to the dilution of equity resulting from offering shares in a buyer company as payment, a buyer’s ability to fund an acquisition through debt will depend on its ability to meet the interest payments and capital repayments without disrupting future cash flows, and also on the strength of its asset base. Taking on a large amount of debt is generally more appropriate for mature businesses which have steady cash flows and don’t have a need for significant future capital investment. Fast growing and capital intensive businesses, or businesses that operate in unstable markets, will more likely consider equity financing.
