Posted on: June 15th, 2020
There are several ways to generate returns in the acquisition market. One way is to buy right, generate moderate growth and pay off your acquisition financing debt. Another way is to accelerate the growth rate of the business, resulting in a larger, more valuable enterprise in the end.
Buyers frequently overfocus on the immediate transaction of buying the business,rather than incorporate the long view of growth acceleration. This often leads to trying to squeeze too much debt into the acquisition financing structure, reducing the level of cash left over to invest in new growth. This causes a problem when a company has an unexpected need for more cash, after the initial deal is closed.
All companies invariably experience this, as projections never materialize as expected. When setting up acquisition financing, it is best to look at it as a three-layer cake. There is a layer of money need to pay the purchase price of the acquisition. There is a second layer of capital needed to operate the business, the working capital. Often the company will be purchased with adequate working capital, but extra working capital availability is always to smart to have. The third layer of capital is needed to launch the company into a new growth wave, the growth acceleration phase. These integrated layers form the foundation of a smart acquisition financing structure.
Buyer’s usually default to assuming this third layer of capital can be funded out of cash flow post-closing. If the business hits on all cylinders coming out of the gate, this is possible. But it is risky to rely on variable performance to fund this investment.Given the multiples companies are purchased exceeding 5 to 7 times EBITDA, it is a risky proposition to think normal levels of growth will lead to an acceptable return. Acquiring via high levels of debt and accepting the market rate of growth is an unsatisfactory investment proposition. Strategically significant and high velocity growth is needed to ensure the deal pays off in the end.
A multi-pronged plan of strategic growth will include channel expansion, product diversification and add-on acquisition. These maneuvers are often new and invigorating business development paths that need significant amounts of upfront investment to launch. The key is setting up acquisition financing with extra capital for these investments to ensure your company will accelerated and grow value faster. Here are Attract Capital 3 tips for Building Growth Capital into your Acquisition Financing Structure.
- Put more long-term debt or equity into your structure – By seeing acquisition financing holistically with three layers, you increase your capital need for sure. But by bringing more equity or mezzanine debt into the structure, you can often increase your senior debt availability or your seller debt component, thereby increasing cash left over to invest in growth. By putting more long-term capital in your foundation, you gain access to more cash at closing to launch your growth acceleration.
- Maximize your pro forma adjustments – Pro forma adjustments can help increase your EBITDA which increases your acquisition financing debt capacity on multiple basis. If you can qualify an additional $1 million in adjustment, and your debt multiple is 3 times, you have generated $3 million in extra debt capital to invest in growth acceleration.
- Sync up an add on acquisition at closing – Add on acquisitions bring immediate debt capacity, and often can be purchased at a lower multiple than your enterprise value. The cash arbitrage between your debt multiple and the cash needed to fund the add on can be used to invest in growth.