In the present financial climate, securing the best financing terms for growth and acquisition financing can prove to be quite a challenging task. Various parameters, including the type of business being acquired, the valuation of assets and cash flow, the perceived market risk as well as growth credibility, need to be assessed. This assessment will determine which capital sources and financing structures can be used. Furthermore, each type of transaction will have its unique set of evaluation criteria, cost of capital, expectations, deal terms, and covenants, which all play an important role in the final decision.
Listed below are the commonly used growth and acquisition financing structures that companies can opt for.
Bank financing:
Bank financing is usually available for a company that has a positive cash flow, a strong profit margin and plenty of assets. However, the level of difficulty of securing bank financing increases if you want to buy an asset light service company. Asset light service companies generally only have receivables and lack additional hard collateral to secure the loan. Recent studies have shown that quality of cash flow, debt load, and insufficient collateral as being cited as the main reasons for banks refusal to lend. One way to improve your chance in obtaining bank financing is to find a bank that has a history of financing the type of business you are buying.
Seller financing:
Seller financing, where the seller finances part of the transaction, is commonly sought after in small and middle-market transactions. Typically, seller financing occurs when the buyer makes a down payment and the seller carries a promissory note for the rest of the purchase price. Monthly payments usually start 180 days from the date of sale. However, the terms (interest rates, length, principal payments, etc.) will vary depending on the negotiated agreement. Generally, the seller note might run for three to five years and carry an interest rate anywhere from 3% to 5%.
Equity financing:
This is the most expensive form of financing and involves the offer and sale of the buyer’s securities for the purpose of raising capital to pay the seller and to provide working capital for the new company. Generally, in such transactions the buyer seeks equity from different sources including private equity firms, venture capitalists, and angel investors. If choosing equity financing, the owner has to be willing to give up a significant amount of control of the company, sometimes as much as a 51 percent majority stake. Equity financing while providing a debt-free solution for the buyer could lead to loss of controlling stake.
Asset-based financing:
An increasingly popular source of financing, asset-based loans are revolving loans secured by the available collateral, such as inventory, accounts receivable, equipment, and fixed assets. Generally, the amount that can be borrowed lies between 50 percent and 80 percent of the asset class. However, asset-based financing has a few drawbacks – the rate of interest and the lack of capital availability. Rates can range as high as 20% in some cases and asset based lenders never extend capital beyond the liquidation value of their collateral, crimping a borrower’s availability.
Mezzanine financing:
A hybrid of debt and equity financing, mezzanine financing is long term& flexible financing based on the underlying cash flow of the borrower. Its term generally extend from 5 to 7 years and the structure of the loan is customized to accommodate existing loans and future cash flow needs of the borrower. A fast growing debt structure in the private capital markets, mezzanine capital is extremely advantageous for middle market companies as it requires not having to give up much equity to gain sufficient money for growth capital and acquisitions. It is a great equity substitute as it’s far cheaper but just as versatile as equity investment.
To get the best possible financing terms and improve the likelihood of success in any deal structure, make sure you consult with an experienced financial advisor familiar with the various debt structures of the private capital markets.