Acquisition Finance Strategies Investors Won’t Tell You About

Investors like their returns and keep their cards close to their vest when disclosing acquisition finance strategies. Equity investors with large funds like to create the impression that they will put all the money into the deal, especially an acquisition finance type deal. If you need $50 million in acquisition finance, and your bank suddenly has short arms, founder owned companies often turn to equity investors to bridge the gap between the bank and the full capital need. Equity investors are clever at exuding capital confidence to convince an unsuspecting prospect that they have all the money you need. They do not always disclose how they plan to structure the investment up front.

The Reality Behind Acquisition Finance Commitments

This tends to happen when the company is blissfully unaware that the investor plans to put in only a portion of the total acquisition finance as equity and arrange for a large loan for the rest. So when the equity investor, initially seen as the capital messiah, lays off 75% of the capital to a lender, the company gets a jolt of reality. Companies who do their homework upfront will easily know this, but many do not.

Preferred Stock and the Return Trap

Also, the type of security provided by the investor can have major implications for returns down the road. While most are preferred stock, there is a range of different types of preferred that can bite you on the back end. Some have rights to get their principal and their cumulative preferred dividend on top back first. This means that if you have $100 million of exit value to distribute, they get back their initial investment of $12.5 million plus 3 years of 8% dividends or a $1 million per year, or $15.5 million in total returned first. So if the investor owns 30%, the investor ends up with 30% times $84.5 million plus $15.5 million or $40.9 million or 41% of the total pie. The Company ends up with $59.1 million or 59% of the total pie. This is a far cry from the initial 70%-30% split due to the need to redeem the preferred principal.

Why Founder-Owned Companies Need Advisors

Acquisition finance strategies are complex and the wrong type of investment can sour even the most exuberant return scenario. All founder owned companies need to have trusted strategic funding advisors on their teams to make sure all major deal points are transparent and easily understood.