Extra Time – The Key Component in Acquisition Financing

Posted on: October 7th, 2021

acquisition financing

Acquisition financing structures usually have several layers of different forms of capital. Most garden variety acquisition financing structures contain a blend of debt and equity capital. Within the debt capital stack, there can be one or more kinds of debt, ranging from bank loans to mezzanine loans.

Purveyors of acquisition financing are conditioned to differentiate their value- add based on price and value. The saying goes – we charge more because we lend deeper into the capital structure. In going down the risk spectrum, we require a higher risk adjusted return. This all makes logical sense, but most borrowers have little appreciation of the highly refined concept of lender risk spectrums. They buy and run businesses and generally don’t evaluate their acquisitions through this type of risk prism.

Challenges of Acquisition Financing

Most acquisition sponsors see integration risk and scale-up risk as their biggest challenges. They are uber-focused on executing the growth plan and taking the business to a higher level of performance. Smart acquirers make sure they have adequate capital for the scale-up at hand. For most, the unpredictability of the timescale is the biggest issue they will face. Extra time is always needed to achieve the desired growth objective.

Along the way companies encounter unforeseen obstacles such as delays in staffing up, new products, new systems, and new operational capacity. Having extra time for the scale up is critical to ensure that the company can turn things around and get back on track. Conservative time factors should be engineered into the acquisition financing debt structure, on the front end of the deal. This can be in the form of extended interest only periods, one-time principal holidays, and 100% back ended principal repayment.

Extra time gives the company operational flexibility to make the tough decisions and stay the course when the road gets bumpy. Acquisition financing lenders should emphasize the time-based value their structures provide. This is the real nuts and bolts benefit to the company dealing with operational uncertainty along their scale-up journey.

During their underwriting processes, acquisition financing providers analyze probable performance projections for their proposed borrowers. The underwriter often toggles between a few scenarios to sensitize the growth variables leading to slower revenue and margin growth over time. The lender’s underwriting view is usually an extension of its credit intelligence and historical experience.

Mezzanine debt loans occupy the risky echelon beneath the bank but ahead of the equity in a capital structure. They are naturally subordinated to the bank loan via an intercreditor agreement wherein the senior lender retains the power to block their interest or force them to standstill.

In the middle market, acquisition financing providers are regarded as super intelligent and hardworking. They have distinguished themselves at elite banks or consulting firms and possess the ability to synthesize voluminous levels of info into a coherent, succinct takeaway or observation. This skill is extremely valuable in attributing causation to business drivers in a financial model used to foretell the future.