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Acquisition Finance (M&A)- financing your acquisition and M&A transactions



The global merger and acquisitions (M&A) market flourished in 2021 touching the all-time high deal value of $ 4.9 trillion. The growing number of public companies, which are more acquisitive than their private counterparts, reverses a nearly 20-year trend and bodes well for future M&A activity. Such a high-growth market situation demands more sources of acquisition financing, and the financing of these deals plays a crucial role in the growth of global M&A deals in 2021.

Acquisition financing refers to the different forms and sources of capital used to finance a merger or acquisition. Unlike some other transactions, this often involves using different types of financing.

How to finance acquisitions?

There are conventional routes and alternative financing sources to finance an acquisition transaction. Traditional sources are basically bank finance and alternative sources include Business Development Companies (BDCs), private equity funds, private debt funds, investment banks, private lenders etc. A traditional bank financing might only approve a loan if the company that is poised to be acquired is profitable, asset-rich, and offers a steady revenue stream. Alternative lenders are a viable option for companies facing such circumstances.

Acquisition Finance (M&A)
Different types of acquisition finance (M&A)

The following are some of the most common types of acquisition finance (M&A) through alternative lenders:

1. Equity Financing

Equity financing is the raising of acquisition capital through the sale of equity in the acquirer company. Such equity financing is desirable for those target companies that operate in unstable industries and with unsteady free cash flows. It is the most expensive form of capital.

However, there are circumstances in which equity financing could be suitable. When the target company is in a volatile industry or does not have a steady cash flow, the companies may choose equity financing as the viable option, as the equity financing does not have payment deadlines or expectations, it is also more flexible than the alternatives.

2. Stock Swap

A stock swap is the exchange of common stock in the merged company as consideration of the acquisition price. When the owner of the target company wants to retain a portion of the stake in the combined company to remain actively involved in the operation of the business, they prefer stock swaps. Here, the stock valuation of the combined entity is important.

3. Acquisition through debt

Debt is regarded as a cheaper way to obtain financing for the acquisition, compared to the expensive equity option. Very few companies can pay to acquire another business with cash, and even when they are able, most refrain from doing so for the sake of long-term budget concerns. That’s where debt financing comes into play.

Acquisition through debt can include senior debt, asset-backed financing, or subordinated debt, all of which are considered inexpensive and advantageous when it comes to tax purposes.

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Bridge financing

Mezzanine financing

4. Cash acquisition

Cash acquisition finance (M&A)means the swapping of shares of the target company in exchange for cash. In an acquisition, if the acquiring firm does not want the target firm to own stock or have voting rights, it can offer cash rather than an exchange of equity. Cash acquisitions often happen when the target company is smaller in size.

5. Seller financing/ Vendor financing

Instead of acquiring the target company for a lump sum payment, the seller agrees to let the buyer spread the payment over a number of years after they put down a down payment. Seller financing is often the most suitable option when obtaining capital from outside becomes difficult. The seller financing may be through delayed payments, seller notes, earn-outs, etc.

6. Leveraged Buyouts (LBO)

A Leveraged Buyout (LBO) is the acquisition of the target company using a significant amount of borrowed money/ debt (“leverage”) to meet the cost of acquisition. An LBO is a unique mix of both equity and debt that is used to finance an acquisition. It is one of the most popular acquisition finance structures. In an LBO, the assets of both the acquiring company and the target company are considered secured collateral. The acquirer’s ultimate goal is to realize an acceptable return on its equity investments upon exit, typically through a sale or IPO of the target.

7. Acquisition through Mezzanine or Quasi Debt

Mezzanine or quasi-debt is an integrated form of financing that includes both equity and debt features. Mezzanine financing may be considered if the target company boasts a history of steady profitability as well as a strong balance sheet. This type of acquisition funding features aspects of both equity and debt financing; mezzanine funding can also often be converted to equity if that is desired. Interest on mezzanine debt is tax-deductible, which is a compelling feature.

8. Earnout

An “earnout” is a contractual mechanism in a merger or acquisition agreement, which provides for contingent additional payments from a buyer of a company to the seller’s shareholders. Earnouts are typically “earned” if the business acquired meets certain financial or other milestones after the acquisition is closed. An earnout is suited for target companies that are flexible and looking for an exit. This might occur when a business owner is looking to retire, for example, and wants an opportunity to generate some short-term returns in the process.

Four ways a business acquisition can add value to your business
  • Business acquisitions can increase market share by bringing access to a new set of customers or a new region. A business operating solely in London could expand into the West Midlands or Greater Manchester on route to developing a national capability
  • Business acquisition in an operational environment can bring significant economies of scale resulting in reduced unit costs and enhanced gross margins. This feeds into the ability of the company to compete successfully on new projects for clients that previously would have been out of reach.
  • A successful business acquisition can reduce risk by diversification of technology, product or market.
  • A business acquisition can accelerate the adoption of new technologies and/or new skills into the existing workforce.

Acquisitio Finance (M&A)

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