Posted on: August 12th, 2021
Closing an acquisition financing is never an easy task. Deal processes are highly engineered work streams that require specialized expertise, issue awareness and project management. Experienced acquisition financing advisors smooth the acquisition financing path through understanding the lender’s process and bringing situational awareness to their clients.
Acquisition Financing Lenders Diligence
The bulk of the acquisition financing lender’s diligence is on the historical financial performance, but there is also a focus on other issues such as management quality, strategic plan, and scaling capacity. Throughout the lender’s process, there is always a level of concern about their ability to close. Are they onboard, have they found anything material, is it different now than they thought it was upfront? There are some of the many thoughts that prospective borrowers have. Should the process falter, borrowers often assume that it may have more to do with the lender than their company. In times of economic tumult or portfolio distress, this is often the case.
When acquisition financing lenders decide to pass on a deal in a good economy, it is almost always a reflection of a negative diligence finding. There are any number of reasons why a lender passes on a deal, but it usually comes down to a handful of issues, particularly in middle market deals. While it is always a jarring experience when a lender punts on a deal, there is value to gained from fully processing their reasons. This information can help a company better understand itself in an objective way. Through digesting these reasons, companies can address any weakness and elevate their game prior to embarking on a future process. The top 5 reasons acquisition financing lenders pass on deals are:
- Low quality EBITDA adjustments – The financial diligence process reconciles the Company’s version of pro forma adjusted EBITDA with the lender’s version. Often, companies are less rigorous about qualifying adjustments upfront which leads to inflated levels of EBITDA. This leads to EBITDA dilution which leads to a drastically higher debt multiple outside the range of acceptability for the lender.
- Substandard information reporting – many middle market companies skimp on investing in enhanced reporting systems, especially when pursuing strong growth. They may not have the time or resources to slow down and make the change. As the business grows, it gets beyond the management span of one person and better information is needed.
- Organizational Immaturity – acquisition financing lenders look for seasoned companies with strong management teams. Most successful companies have been through a few economic cycles and have successfully repositioned.
- Discomfort with the industry – acquisition financing lenders need clarity around need for the product and the demand drivers for the product. For mid-sized companies that sell a piece of a larger product, it’s often hard to articulate the demand drivers and industry trends sufficiently.
- Concern about management character – lending involves a leap of faith and lenders need to feel comfortable with the business leaders. If background checks or other interactions raise questions about their character, lenders will often take a pass.