Keys To Selecting The Right Debt Structure

Posted on: November 22nd, 2021

debt structure

As in most things in life, a few key decisions determine a lot. And so, it goes with the selection of a debt structure for your acquisition financing. Debt structure selection is paramount and has a large influence over the fate of your deal.

Debt Structure for Successful Deals

Successful deals use debt structures that provide incremental financing, extra time for performance and a collaborative lender relationship. Less successful deals include miserly financing proceeds, short repayment periods and highly transactional lenders. There are many debt structures each with their own underlying methodology, based on the lender’s view of risk.

Asset based structures are tightly framed to collateral values on a real time basis. This loan structure usually does not deliver enough financing for M&A and is primarily used for working capital support. Cash flow-based debt structures are framed to the future cash flow value of the company. This results in larger loan sizes and much longer loan terms, resulting in a generous performance runway for an acquirer. Loans pegged to cash flow value are not backed by hard collateral and result in the need for the lender to be more collaborative with the borrower. When selecting a debt structure, there are 4 key variables to bear in mind:

De-risk your acquisition plan – acquisition risk in the form of integration risk is omnipresent. Having a longer term and more evolved debt structure can help de-risk your acquisition, by giving you more time and more liquidity to recover from surprises.
Initial Performance Counts – acquisitions that start strong usually end up being successful. Those that stumble out of the gate, usually limp for the remainder of their life. Ensuring that you can perform strongly out of the gate is important. The right debt structure can ensure this happens.
The Rule of 2X – often in deals, initial acquisition assumptions are wildly off-base. New investments and implementation periods often cost twice the initial amount and take twice as long. A quality debt structure is a valuable insurance policy to mitigate this risk.
It’s All About Capital Availability – in the end, most successful deal operators will tell you that the key to success is the amount of capital they had access to, not necessarily the price or the cost of the capital. Higher end debt structures deliver more proceeds and can even provide follow-on financing.

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.

The deal world thrives on the belief that the institution providing acquisition financing will deliver on their promise. Lenders usually telegraph their capital capabilities early on during the sales pitch and give their deal sizes and hold levels for their fund.