If you are looking for a step change in the growth of your company, then considering the acquisition of another company might be an elegant solution that brings to mind one big question – How do I fund the purchase? The value of a company is typically a combination of the assets being purchased, the size of the acquisition and risk profile of the target company. It’s easier to access a variety of institutionally backed finance where an acquisition has a lot of physical assets than it is to finance the purchase of a service-based business. The key area for proprietors to focus on is the business cash flow. The risk of any potential revenue disruption, business continuity or unidentified costs are usually exposed in a Due Diligence process.
Funding options available to SMEs include –
- Equity
- Earn in/out structures
- Debt
- A combination of the three
Each option will be more or less attractive or accessible depending on the relative business size of the interested parties, the combined Balance Sheet position, established bank/debt funding relationships and buyer and seller motivation.
Earn in/out structures are more common for the SME market and have built-in risk-adjustments where the combined business earnings capacity generates a substantial contribution to the purchase price over time. This approach means that exiting owners remain exposed to business performance and risks not identified in the acquisition process, giving comfort to the buyers. Acquisitions funded by equity often rely on the buyer to have the capacity and ability to deal with incremental lump sum investments, either on their Balance Sheet or via new investment. Funding an acquisition on this basis should reflect the continuity risk for sell-side owners in the future business performance.
Acquisitions that have significant strategic benefits and are relatively small compared to the acquiring business are often the most straight forward to execute. The larger the acquisition, the more consideration is required especially around control issues.
Debt funding for acquisitions is a viable option, especially where there is an established relationship with a financier. The use of debt funding for acquisitions will depend on the stability of business cash flows and the potential risks from costs not identified in the due diligence review process – mostly this is in the costs associated with staff, compliance, tax, customer, and supplier to name a few. Lenders need regular reporting and controls in the business to give them the comfort that the debt is being managed correctly. It’s important that debt facilities are properly structured to meet the needs of the business as a whole.
If you are contemplating an acquisition or raising debt facilities to grow your business or looking for a deeper dive on the points above, contact us.