Five Capital Stack Optimization Tips

Posted on: June 19th, 2019

Capital Stack Optimization

Making an acquisition is a massive decision in the lifecycle of a company. It introduces a lot of new things for a business to manage. Some of the most important variables are how long the integration takes, how employees react to new ownership and how much extra capital is needed for investment. Architects of acquisitions tend to think in numbers and often these softer issues get a bit overlooked. 

Due to the lack of clarity around these variables, it pays for acquirers to go into a deal with an insurance policy in their back pocket. Acquirers need the power and confidence to know that whatever may arise post-closing, they have the resources to manage through it successfully.  This occurs when you plan appropriately on the front-end and design cushion into your capital stack.   Deals succeed when the underlying capital stack provides the proper quotient of time, flexibility and capital.  Few acquisition deals perform exactly as planned and most stumble at one point.   Most deals have some large unexpected investment need such as an IT upgrade or capacity expansion, that surfaces post-closing.

The key is to make sure you have available resources to remedy the situation at hand.  Some acquisitions need more time to combine resources and attack the market.  These deals benefit from a more back-ended capital stack structure, when principal payments are deferred, and covenant levels are low.  Other deals need more cash on hand at closing to make accelerative investments.  This involves bringing in extra layers of capital such as stretch financing or equity.  Some deals, where growth is imminent need more working capital investment.  Through thinking deeply about the likelihood of each outcome, you can customize your capital stack to mitigate each risk.  Here are the Attract Capital Five Capital Stack Optimization Tips.

  1. Create a capital cushion– many acquirers bootstrap their way into a closing and lack enough cash to invest in growth. A capital cushion gives you the fuel to power growth, through both good times and bad.
  2. Operationalize your timelines – avoid the temptation to use finance driven timelines as your guide in designing your capital stack. Have your management team, not your finance team, figure out how much time is needed, and build your stack around these inputs.
  3. Ensure time factors are aligned – short term financing does not align with long term acquisition growth. Sooner or later, you will be forced to extend your loan maturity or face illiquidity. Long term capital is an acquirer’s best friend.
  4. Supersize your loan– the success of your deal is highly correlated to how much capital you have access to. If your lender will advance a larger loan, take it.
  5. Use multiple loan layers to create dynamic debt capacity – A strong junior debt level will allow you to quickly build up more senior capacity as you grow. This can be utilized to take out more expensive junior debt or for more acquisitions.