What Acquisition Financing Options Exist When Banks Say No

Banks used to be a big force in the acquisition financing market. Many used to provide loans directly to their best customers. Nowadays, most banks participate in acquisition financing indirectly through funding private equity sponsored buy outs. In today’s banking market, a direct loan to a non-sponsored deal is a rarity due to the industry’s conservatism and regulatory oversight. In fact, most banks, especially large banks, are largely irrelevant to middle market acquisition financing outside of the private equity model.

The Rise of Private Credit Lenders

As the private credit industry has evolved over the past 25 years, new lenders have emerged to become the go-to options for acquisition financing for founder-owned companies. These private credit lenders think differently than banks, akin to businesspeople as opposed to regulators. In stead of looking for a reason to not do a deal, these lenders look for the positives of the deal and try to make it work. They are attuned to what makes a company special, its competitive edge that keeps revenue growing and margins strong. They value businesses the same way as private equity investors based on a multiple of a company’s adjusted EBITDA, which gives them latitude to provide a large loan.

Loan Structures and Leverage Levels

The most popular type of non-bank acquisition lenders are private credit funds that offer both senior and subordinated debt in a single loan structure. They will generally lend up to 3.5 times EBITDA for companies with EBITDA from $5 million to $8 million. They will increase to 3.75 to 4.5 times for companies with EBITDA from $10 million to $15 million.

The Role of Mezzanine Debt and SBIC Funds

Mezzanine debt lenders, especially SBIC’s are also an option for acquisition financing especially for smaller companies with EBITDA between $3 million and $7 million. The SBIC mezzanine fund model has been around for 30 years and can be a good option for companies needing acquisition financing on a one-time basis. Newer SBIC funds, who have raised capital over the past several years are often better lenders to partner with.

Structured Equity as an Acquisition Financing Option

In addition, structured equity funds offer acquisition financing in a slightly different envelope than private credit or mezzanine lenders. Their capital is set up as redeemable preferred stock which requires a contractual payment at maturity. There is no current dividend or principal payment due which gives the company the opportunity to grow before repayment is due.