Posted on: July 20th, 2018
The mergers & acquisitions market has been very active so far in 2018 and all signs suggest this trend will continue. With many buyers in the market, prices are higher which renders it difficult for a buyer to acquire a company without investing large amounts of equity.
This poses no problem at all to private equity firms, who can dish out equity and easily borrow more from willing lenders. However, for other buyers, putting in a huge amount of equity to complete a deal is not desirable, so let’s look at two main ways around this.
The first strategy for making an acquisition without large amounts of equity is to simply qualify for a larger loan. Currently, lenders will only finance at about 4 times your company’s cash flow.
So, if the target company’s purchase price is 6 or 7 times your company’s cash flow, your cash equity available may not be sufficient. However, you should consider revaluing the EBITDA with adjustments—taking into account costs that will be reduced post-closing.
As long as the cost will be permanently reduced post-closing, you can add them back to your actual EBITDA. If your adjustments are credible and explained clearly, then these adjustments will increase your EBITDA.
This will reduce your price to EBITDA multiple, allowing you qualify for a larger loan from your cash flow lender.The second strategy to alleviate the burden of putting in lots of equity is to give the seller a stake in the future of their company.
This can be executed by issuing seller notes or earn outs as part of the acquisition. Essentially, these tactics involve the seller agreeing to receive the rest of the purchase price at some designated point in the future, giving you and your company time to come up with the money.
Another option is to have the seller keep a small amount of equity. Say, for instance, the seller rolls over 10-15% of his shares, then that portion of the business does not need to be purchased, which lowers purchase price while still allowing the buyer to have clear control over the business.
When it comes to making acquisitions, private equity firms are like the New York Yankees. They represent a big-market team with all the fan-favorite, power hitters.
They have seemingly endless money, allowing them to pay the high prices demanded in the current M&A market. Mid market companies are more similar to small-market teams.
They may not be able to sign all the big names, but they can still compete employing different small-ball strategies to win.
Bunts, sacrifice flies, and stolen bases are the counterparts to mid market companies keeping acquisition prices down through seller notes, earn outs, and allowance of the seller to keep some equity.
Key Strategies to Make Pricey Acquisitions Achievable
- Raise more funding
- Raise EBITDA by revaluing with explained adjustments for costs that will surely be lowered in the future
- Raising EBITDA lowers the price to EBITDA multiple, allowing your company to borrow more
- Give seller skin in the game
- Using earn outs or seller notes, part of the payment is paid later down the road, allowing your business more time to generate the money needed
- Allow the seller to keep a small portion of the business in order to reduce the purchase price