Posted on: July 10th, 2020
Acquisition financing is often seen in a functional light as dollars needed to close at a certain price. Often people get price fixated in their search for acquisition financing, as if a few extra savings in basis points will make or break the deal. Acquisition financing is most appropriately viewed through a more strategic prism that emphasizes the value of the financing, the amount of the raise and the flexibility of the structure. Focusing on these three keys will help you optimize your acquisition structure and lead to a greater likelihood of closing and long-term success. Value of financing means what you receive from the lender in exchange for what you pay them.
Low rate loans often have fast repayment and strict covenants. There is a direct relationship between the interest rate and risk tolerance, that acquirers frequently overlook. If your bank is only making 4% interest on their loan, then it needs to be a very low risk loan with a negligible write off risk. Low rate loans are almost universally senior loans and provide lower amounts of financing, shorter repayment terms and far less flexibility than non-senior loans.
Higher rate loans, such as mezzanine loans, provide larger amounts of financing, longer repayment, and far more flexibility than senior loans. Whilst you are paying higher rates, you are getting a more valuable structure which brings significant benefits.
Smart deal makers understand these core principles and align layers of both low and high rate loans in a complementary blend, to optimize their deal structure. Successful acquisitions are like most things in life – they take longer than expected and will cost more than expected. The key risk in a leveraged situation is running out of money to operate and invest in the business.
With a longer-term acquisition financing structure, you avoid having to use your valuable cash flow to repay principal, freeing you to invest in growth and ensure achievement of long-term growth targets. Additionally, principal repayment deferral allows you to build up a liquidity cushion, which can be used as rainy-day fund to get through tough times.
The recent economic pain caused by Covid-19 underscores the need for more liquidity on the balance sheet.
Here are the Attract Capital top 3 keys to Acquisition Financing success.
- Fold in growth capital into your structure – instead of overfocusing on how much is needed to close, prioritize how much is needed to safely grow the business. If you cannot grow the company post-closing, it is unlikely you will earn enough return to make the deal worth your time and effort.
- Always be willing to pay extra for more funding and more time – optionality is a precious thing with acquisitions. Extra time and extra capital are the foundation of optionality. Focus on how quickly the lender wants the money back, and how they have handled other situations that have taken longer in their portfolio.
- Overcapitalize your deal with long term repayment debt– resist the temptation to load up on cheap, short term debt. Mezzanine financing is a great way to base load your structure and gain equity like strength.