Ac uisition

Finance
Different options for funding acquisitions
What is Acquisition
Finance?
Acquisition finance refers to the different
sources of capital that are used to fund a
merger or acquisition. This is usually a
complex mission requiring thorough planning,
since acquisition finance structures often
require a lot of variations and combinations,
unlike most other purchases. Moreover,
acquisition financing is seldom procured from
one source. With various alternatives available
to finance an acquisition, the challenging part
is getting the appropriate mix of financing that
offers the lowest cost of capital.
What is Acquisition
Finance?
Acquisition finance refers to the different
sources of capital that are used to fund a
merger or acquisition. This is usually a
complex mission requiring thorough planning,
since acquisition finance structures often
require a lot of variations and combinations,
unlike most other purchases. Moreover,
acquisition financing is seldom procured from
one source. With various alternatives available
to finance an acquisition, the challenging part
is getting the appropriate mix of financing that
offers the lowest cost of capital.

Companies can grow in various ways, such as

by increasing their workforce, launching new
services or products, expanding marketing, or
reaching new customers. However, the
abovementioned growth methods are often
less exciting to investors. Apart from rapid
growth, synergistic acquisitions can offer other
significant benefits such as economies of scale
and increased market share. However, the
acquisition of another company is a major
decision that needs sound financial resources.
Types of Acquisition Finance

Let's look at some of the popular acquisition

financing structures that are available:

1. Stock Swap Transaction

When companies own stock that is traded

publicly, the acquirer can exchange its stock
with the target company. Stock swaps are
common for private companies, whereby the
owner of the target company wants to retain a
portion of the stake in the combined company
since they will likely remain actively involved in
the operation of the business. The acquiring
company often relies on the proficiency of the
owner of the target firm to operate effectively.

Careful stock valuation is important when

considering a stock swap for private
companies. There are various stock valuation
methodologies used by proficient merchant
bankers, such as Comparative Company
Analysis, DCF Valuation Analysis, and
Comparative Transaction Valuation Analysis.
4. Acquisition through Debt

Debt financing is one of the favorite ways of

financing acquisitions. Most companies either
lack the capacity to pay out of cash or their
balance sheets won't allow it. Debt is also
considered the most inexpensive method of
financing an acquisition and comes in
numerous forms. When providing funds for an
acquisition, the bank usually analyzes the
target company's projected cash flow, profit
margins, and liabilities. Analysis of the
financial health of both the acquiring company
and the target company is a prep course.

Asset-backed financing is a method of debt

financing where banks can lend funds based
on the collateral offered by the target
company. Collateral may include fixed assets,
receivables, intellectual property, and
inventory. Debt financing also commonly
offers tax advantages.

4. Acquisition through Mezzanine or Quasi

Debt

Mezzanine or quasi-debt is an integrated form

of financing that includes both equity and debt
features. It usually comes with an option of
being converted to equity. Mezzanine
financing is suitable for target companies with
a strong balance sheet and steady profitability.
Flexibility makes mezzanine financing
appealing.
4. Acquisition throug h Mezza nine or Quasi
Debt

Mezzanine or quasi- debt is an integra ted form

of financ ing that includes both equity and debt
features. It usually comes with an option of
being conve rted to equity. Mezzanine
financ ing is suitab le for target compa nies with
a strong balance sheet and steady profita bility.
Flexibility makes mezzanine financ ing
appea ling.

5. Leveraged Buyout

A leveraged buyou t is a unique mix of both

equity and debt that is used to financ e an
acquis ition. It is one of the most popula r
acquis ition financ e structu res. In an LBO, the
assets of both the acquir ing compa ny and
target compa ny are considered as secured
collateral.

Companies that involve thems elves in LBO

transa ctions are usually mature , possess a
strong asset base, genera te consis tent and
strong operat ing cash flows, and have few
capital require ments . The princip al idea
behind a leveraged buyou t is to compe l
compa nies to yield steady free cash flows
capable of financ ing the debt taken on to
acquir e them.
6. Seller's Financing/ Vendor Take-Back
Loan (VTB)

Seller's financing is where the acquiring

company's source of acquisition financing is
internal, within the deal, coming from the
target company. Buyers usually resort to the
seller's financing method when obtaining
capital from outside is difficult. The financing
may be through delayed payments, seller
note, earn-outs, etc.

Modeling Acquisition Financing

When building an M&A model in Excel it's

important to have a clearly laid out set of
assumptions about the transaction and the
sources of cash (financing) that will be used to
fund the purchase of a business or an asset.
Below is a screenshot of the sources and uses
of cash in an M&A model.
How to Finance a
Business
Acquisition in 2022
So, what is acquisition
financing?
Acquisition financing is the way in which a
company funds a merger or acquisition.

How do companies finance acquisitions?

They do it through various types of capital.

In fact, larger companies and deals might
leverage more than one method of
financing.

With the beginning of the year balance

sheet showing a healthy cash balance, you
may be encouraged to seek out an
acquisition in the coming months.

But there's more than one way to fund an

acquisition than simply tapping company
funds. In fact, there are many acquisition
funding options and methods.

The right business acquisition finance

depends on your business, the business
being acquired, and where both are in their
c cle.
How does acquisition
financing work?
smaller companies can reap multiple
benefits from acquiring other companies,
such as business synergies and economies
of scale.

In order to acquire another company, the

buy-side must review different business
acquisition financing options (10 are
described and analyzed below).

Let's start with an overview of all the m&a

financing options and how to fund an
acquisition.
How to finance a
business acquisition

1. Company Funds

2. Company Equity

3. Earnout

4. Leveraged Buyout

5. Bank Loan

6. SBA Loan

7. Asset-Backed Loan

8. Issuing Bonds

9. Third-Party Financing

10. Joint Venture

1. Company Funds
Let's start with the first acquisition financing
method. As mentioned at the outset, if your
company is fortunate enough to hold plenty
of cash, it may be possible to acquire
business by means of a transaction which is
100% cash financed.

However, although the vast majority of

acquisitions involve some upfront cash
payment, it's remarkably rare to finance the
entire deal in this manner.

With so many other financing options

available - many of them lower risk than
bringing down your own company's liquidity
- it's best only to consider some form of
hybrid deal that works for both parties.

It's also highly likely you'll need some of that

cash balance during the post-merger
integration of the newly acquired business.
2. Company Equity
Offering equity to the owners of a target firm
can be an excellent way of smoothing the
process, particularly where they're
interested in maintaining some control.

Assuming both firms merge into a new

entity, this would involve giving them some
equity in the newly merged firm. (With the
equity share offered to them being based
on a valuation of the new firm by an
objective third-party).

Alternatively, it could be that both firms

remain separate entities under a holding
company, and the equity share is based on
a valuation of the target firm.

In both cases, the benefit to you is paying

less cash and retaining some of the seller's
expertise and insight, thus making
company equity a powerful acquisition
funding option.
3. Earnout
An earnout is one of the most creative ways
to finance an acquisition. This works best
where the seller is already considering an
exit and is relatively flexible on payment
terms.

The benefit of an earnout to a seller is that

most ( or in some cases, all) of the
transaction fees that you pay are
contingent on the firm's ongoing success.

So, to take a basic example, you could pay

30% of the firm's value upfront and 20% of
its revenues in each of the first five years
after the acquisition. You can see how this
could become creative quite quickly,
involving all manner of triggers and
clauses.

But in cases where, say, an owner is looking

to retire while his or her business still has
plenty of roads to run, an earnout allows
them to benefit from the medium-term
revenues in the short term.

And still, leave the business and enjoy

retirement in the short term.
4. Leveraged Buyout
Leveraged Buyouts ("LBOs") gained
notoriety in the 1980s as major corporate
leveraged buyouts gained popularity, but
they're not restricted to blue-chip
companies.

Leveraged buyouts are similar to earnouts in

the sense that they allow the buyer to
commit very little of their own capital.
Instead, you use leverage ( debt) on the
assets of the business being purchased.

Of course, this demands that you're able to

generate enough cash flow to cover the
debt service from the cash flow generated
by the acquisition.

If this sounds like a high-risk, high-reward

strategy, it is. An LBO has a huge payoff if
you manage to pull it off, but it can quickly
sink those businesses that don't.

But, let's review business acquisition funding

through acquisition loans.
 What is a business
acquisition loan?

A business acquisition loan is a loan given

to a company for the specific purpose of
acquiring another company or asset; it is
a common way of financing an
acquisition. There are often restrictions
that accompany these loans, such as
time limits. The lender also determines
the amount of the loan and who is eligible
for the loan.

5. Bank Loan

This method of business acquisition

financing doesn't require much explaining.

Most banks, even those dealing with SMEs,

have specific provisions put aside for
business acquisitions. With interest rates
remaining historically low, 2021 should still
be a good time to avail of this option.

Although it's never a bad idea to shop

around when looking at debt options.

Your own bank will often provide the best

terms: aware that the future prospects of
your business are looking positive, they'll be
keen to keep your business in house.

It goes without saying that this is an angle

that you should leverage when looking for a
bank loan for a business acquisition.
6. SBA Loan
SBA loans will cover 75% of the value of
acquisition between $150,000 and $5
million.

There's a long checklist of items that you'll

need to deal with before obtaining an SBA
loan, but it's one of the most straightforward
methods of financing available.

The interest rate available is also

competitive, currently coming in at around 8
to 10% for loans of over $50,000.

The repayment can be made over a period

of seven to ten years. It means a well-
planned acquisition should safely cover the
loan interest expenses, allowing your
business to benefit from the extra cash flow
in the short-term.
7. Asset-Backed Loan

An asset-backed loan is similar to a

leveraged buyout in that you're essentially
using the value generated by the target
company to acquire it.

However, unlike a leveraged buyout, where

the financing is generally provided on the
basis that you can show that the acquisition
will generate cash flow, an asset-backed
loan is made on the basis that the assets of
the target firm can be liquidated in the
worst-case scenario.

You're gaining financing on the value of the

target's assets (but not their liabilities).

As with an LBO, this is one of the riskier

strategies for financing a business
acquisition, and it may be difficult to find
someone willing to finance the assets at a
price that meets the seller's valuation of
their own business.
8. Issuing Bonds
Issuing bonds is an excellent way to fund the
acquisition of a business. Although a bond
issue is technically more complicated than
an SBA or bank loan, this method forces you
to think about how you'll pay off the debt in
installments over a given period.

This strategy will be set out in your private

placement memorandum before being
distributed to relevant investors.

There's a considerable amount of

technicality involved here, which varies from
state to state, but you will need to keep a
serial number for each bond sold and to
make payments at regular agreed intervals.

You can set the coupon rate of the bond,

but you should be realistic - are people
going to want to fund your acquisition at a
coupon rate of 5% when they can acquire
the corporate debt of a blue-chip company
at a similar rate?
8. Issuing Bonds
Issuing bonds is an excellent way to fund the
acquisition of a business. Although a bond
issue is technically more complicated than
an SBA or bank loan, this method forces you
to think about how you'll pay off the debt in
installments over a given period.

This strategy will be set out in your private

placement memorandum before being
distributed to relevant investors.

There's a considerable amount of

technicality involved here, which varies from
state to state, but you will need to keep a
serial number for each bond sold and to
make payments at regular agreed intervals.

You can set the coupon rate of the bond,

but you should be realistic - are people
going to want to fund your acquisition at a
coupon rate of 5% when they can acquire
the corporate debt of a blue-chip company
at a similar rate?
9. Third-Party Financing
There's a growing number of non-traditional
finance firms out there that can assist in all
manner of business operations, including
acquisitions.

Typically, these are private equity firms and

their provision of funds will involve them
acquiring some of the equity of the newly
formed firm on the understanding that they
can become involved in some of the
management decisions.

This is not a bad way to go, potentially

allowing you to tap into a new network of
experienced industry professionals that
can generate significant value through your
acquisition.

10. Joint Venture

Although technically not a method of
financing, entering an acquisition through a
joint venture (JV) with another firm can be
an excellent way to gain (joint) control of a
business, with a lower upfront cost.

There are several caveats, however. It can

be challenging to find a suitable JV partner,
as many joint ventures destroy value as
creating it, and your efforts to make
management decisions at the acquired
business may be stifled in the long run by
virtue of controlling less of its equity.

Nevertheless, where two businesses can find

the right harmony, the combined expertise
provided by two sets of management can
generate considerably more value.
Conclusion
Clearly, acquisition funding can take many
shapes and forms depending upon your
company's financial situation and goals.

Although there are many financing options,

the financing strategy for the acquisition is
very specific to the deal.

It should also be noted, acquisition

financing must take into account what it will
cost to run the business after the deal is
done.