In some instances, the best way for a company to increase its presence is by acquiring another business. Such a move can bring access to a broader geographic market and customer base while providing cost savings through improved distribution channels.
Companies hoping to complement internal growth initiatives through an acquisition may turn to acquisition funding. “Acquisition funding is the combination of funding sources needed to complete an acquisition or merger of another business,” explains James Wade, vice president of Comerica Bank’s Western Market.
Smart Business spoke with Wade about acquisition funding, how acquisition transactions are typically structured and the importance of utilizing debt properly.
How are business acquisition transactions typically structured?
As a commercial banker, we typically are working with an established company that is looking to expand its geographic presence in a similar business, vertically integrate for synergistic cost savings or diversifying from a concentrated product or service. Relatively small transactions can be financed by increasing an existing line of credit or funding a new term loan without the need for additional funding sources. This method of financing an acquisition will typically be 100 percent supported by assets.
Larger transactions require more thought, planning and fund sources and there are usually not enough assets to support the amount needed to complete the acquisition. A company can use cash, unencumbered assets, senior debt, seller’s debt (typically subordinated to the senior lender), outside subordinated debt and venture capital.
Why is it important to work with a bank that has experience funding acquisitions?
Time is of the essence when purchasing another company. An experienced lender will help guide the process, increasing your chances of a successful close. It is also important to engage experienced legal and accounting assistance when structuring an acquisition. The effective cost of the transaction may increase if a deal is not structured properly.
What do lenders look for when deciding whether to fund an acquisition?
When there are not enough assets to support a loan, credit decisions are based on the strength and consistency of historical cash flow, management experience and the outlook of the industry.
How can a company increase its chances of having the financing request approved?
Communicate as early as possible about your plans to make an acquisition with your financial partners. Share your vision of the combined companies post merger or acquisition. Have a short-term plan (how you plan to combine the companies) and a long-term plan (how you will be more competitive in the future). Detail the critical components that are going to make this transaction successful. For example, stating you can save $300,000 per year by eliminating the sellers’ salary, country club membership and car allowance is more effective than stating you will save a lot of money combining the companies. Work with your accountant to prepare a closing balance sheet (this will require knowing if you are making a stock or asset purchase which will be negotiated between you and the seller with the advice from your attorney and accountant).
How should a company proceed if its primary lender is unable to fund the entire acquisition?
After evaluating the purchaser’s business and personal assets, talk with the seller. There can be tax advantages for a seller accepting a note. Also, the seller is likely motivated to complete the transaction and has the most knowledge of the business. Your senior lender will most likely require the seller debt be subordinated and may limit principal and interest payments. If additional funds are necessary, your banker, accountant and attorney can provide referrals for subordinated debt and outside equity providers.
Why is it important for a company to be prudent about the amount of financing it acquires?
Utilizing debt the right way can be powerful and provide the capital needed to grow a profitable successful company without diluting the owner’s interest in the company. However, acquisitions add an element of risk to a business. Combining cultures, system integration and facility consolidation are just a few of the issues a company will face after an acquisition. It is important to not affect the long-term competitiveness of a company because the debt service is limiting its ability to invest in people, infrastructure and technology.
How important a role does timing play in acquisition transactions?
Timing is important because there will be fees associated with extending deadlines. Also, the purchaser is at a disadvantage if the seller is having second thoughts. The seller may try to renegotiate terms and conditions or cancel the transaction. Work with your financial advisers before setting deadlines and structure extensions into your agreements.
JAMES WADE is vice president of Comerica Bank’s Western Market. Reach him at (619) 652-5778 or firstname.lastname@example.org.