The Value of Acquisition Financing Tiering

Acquisition financing structures are frequently bespoke and incorporate the different tiers of debt capital to achieve a desired effect. Through tiering the structure, borrowers can reduce repayment levels, extend the maturity, lower the interest rate and create foundational scale-up support. A recent deal illustrates the value of this approach.

In this transaction debt capital was sourced for a roll up deal in both the bank, unitranche and mezzanine debt market simultaneously. The borrower is an established company with significant equity value expanding its regional footprint. The independent sponsor/owner of the platform company was contributing his equity value in this business and requiring 100% acquisition financing from the lenders. The market feedback from each separate debt market channel underscores the value of blending tiers of debt to arrive at the optimal debt allocation formula.

Bank Acquisition Financing Lenders

Bank acquisition lenders were focused on the leverage level of the deal and required high levels of principal repayment immediately after closing. While their interest rates were low, the required principal payments were heavy for the debt service coverage. Though manageable for the combined business, the sponsor was leery of a debt structure that required 20% principal amortization each year for 5 years. Mezzanine debt acquisition lenders approached the deal more like an equity sponsor. They wanted to put in equity and utilized a self-serving structuring approach to provide both an acquisition financing loan as well as a large equity coinvest or equity warrant ask. This created a very low level of principal repayment in the early years of the deal with most of the repayment occurring in the back end of the maturity.

The pricing for this deal was landing at the 14% to 18% level per annum. While this mezzanine approach provides significant repayment flexibility and the virtue of patience, the cost is exorbitantly high and beyond the dilution threshold for the owner. The unitranche approach, a hybrid of senior debt and mezzanine debt, was the winning acquisition financing structure in the end and provided an unbeatable level of low principal payments, low cost and foundational scale-up support. The interest rate of this option was higher than the bank option but significantly lower than the mezzanine debt acquisition financing option.

The repayment profile was on a par with the mezzanine debt acquisition financing option due to the healthy portion of back ended mezzanine debt in the structure. An excess cash flow sweep variabilizes the average life of the loan through providing a flexible mechanism for faster loan principal pay down. Through combining the junior debt with the senior debt and synergizing the strengths of both debt tiers, the borrower realizes unbeatable value with this optimum debt solution.