Avoiding Deal Breakers: Common Pitfalls in Acquisition Financing

There is tremendous creativity in the deal world with opportunistic acquirers in need of acquisition financing.  The US economy has created an M&A market of such breadth and depth that many young acquirers try their hand at acquiring without having any capital of their own to invest. While this may sound insane to some, the rise of a sizable new class of acquirers over the past 10 years – fund less sponsors- suggests otherwise. Fund less sponsors have capitalized on the rise of alternative assets which has democratized access to capital for acquisition financing.

30 years ago, acquisition financing was confined to well-qualified companies or private equity funds. Now it is widely available to people without any capital, if they have a strong deal and a financeable growth plan. Most of these sponsors lack experience as M&A principals and can get overzealous in their pursuit of a deal which leads to deal breaker problems in securing acquisition financing. Lack of equity capital in the deal can cause the lenders to walk. All fund less sponsors need to line up fresh equity capital from other parties to be taken seriously by an acquisition financing provider. You cannot expect a seller note or a seller equity rollover to impress an acquisition financing lender. There must be real equity capital, the proverbial skin in the game, without which most lenders will pass. Often these buyers lay off the purchase price to a seller note but do not appreciate the need to balance seller note expectations of the seller and the acquisition financing lender.

Because of the size of the seller’s note, the seller understandably wants some type of security. This clashes with the needs of the lender who must be in first place with an all-asset lien. This puts the fund less sponsor in an untenable position between lender and seller, in a cage of their own making. Because they do not have any capital to invest, they give the seller whatever they want without realizing that this simply will not work for the acquisition financing lender. This issue needs to be handled early in the process with the seller in a transparent way, for this not to be a deal breaker. Also, seller note repayments also can be a problem for the lender as they do not want any note repayment while their loan is outstanding. Acquirers need to ensure seller note terms are outside of the term of the acquisition financing loan and that all the principal is repaid as a bullet maturity at the end of the term, after the acquisition financing loan is repaid.