Acquisition Financing Solutions in a Troubled Market
Troubled economy and tight credit markets. For those who are not buying companies with cash, its time to get creative on ways to fund an acquisition.
First, let’s start with a little background on the realities of acquisition debt financing: senior and subordinated debt.
In 2008, you may have secured as much as 80% in senior debt, but in today’s credit environment, you’re more than likely looking at no more than 50% or 60% of the enterprise value as senior debt. So, what is the implication and how do you fund the shortfall?
The impact is that there will still be deals, but fewer by each buyer as they are using more of their capital to fund the deal. As an example, if 50% of the acquisition price is funded by senior debt from a lender, then there is still 50% of the sale price to pay to the seller. The other 50% will be a combination of Equity, Sub debt seller financing.
One advantage with the current climate for sub debt lenders (who have subordinated rights to senior lenders) is that valuations are scrubbed very hard and are more realistic. There is a lot less hot air and hype to inflate the valuation. This reduces the risk for a sub debt provider, particularly in a new acquisition. Sub debt providers can be confident that the equity investor (the buyer) has run the numbers hard and is more confident of the valuation, given that more of their money is on the line.
Senior debt lenders have run the numbers, sub debt lenders have run the numbers and the actual buyers of the company have run the numbers. That’s lots of professionals independently checking the validity of the valuation.
FINANCING SOLUTIONS IN A TROUBLED MARKET
You need to think beyond the traditional forms of equity and debt capital to fund the acquisition.
Non-control preferred stock investor
You could take on a non-control preferred stock investor. Preferred stock works in a similar way to subordinated or mezzanine debt, but typically has a guaranteed dividend payment of up to 7% per annum instead of interest payments. Unlike common stock, a preferred stockholder doesn’t get to vote and can’t make decisions, but when its time to redeem the stock or pay out, the preferred stockholder gets paid out before the common.
A preferable scenario for you would be to offer sub debt with a preferred stock kicker, because unlike dividends on the preferred stock, interest payments on the debt are tax deductible.
Essentially, this is a cheaper way of getting sub debt, because part of their potential return will be in the stock appreciation. In the worst case scenario that it did go to bankruptcy, the sub debt holder would be behind the senior debt, but ahead of all the equity investors.
Sale-leaseback on real estate
If a company has lots of value on the balance sheet in real estate, you can buy the company, sell the real estate and lease the real estate back to release the cash. There are a number of specialist firms who focus exclusively on leasebacks of this type. The seller has the cash from the real estate sale, the buyer has a lease payment rather than more cash down at closing. It’s just a disguised way of financing the deal. If you want a local list of firms offering sale leasebacks, give us a call.
Sale-leaseback large equipment
Same deal as above with real estate.
Supplier financing the inventory
A supplier will want to protect their wholesaler or distributor. If the company is changing ownership then the supplier is going to be nervous. They’re more likely to be flexible with the new owners and may even finance the value of that inventory to keep the customer and keep the sales volume. When the company is acquired, then it opens the door to their competitors.
You have substantial leverage in this climate to get the company's suppliers to finance their inventory. For example, if a buyer is consolidating several wholesalers that are all in the paint industry, they can do their due diligence when looking to acquire each company. They find that one of them is holding $500,000 of inventory from one of its suppliers. The buyer then speaks with that supplier and negotiates cost of product post closing. They should also request that the supplier buys that inventory back at closing and the buyer can use the money to finance part of the acquisition.
As a concession, you may agree to keep that supplier as your main source of supply until you have paid for that inventory or for a fixed period of time. Again, it’s a way of committing less capital at closing. The supplier doesn’t carry much risk. If you miss a payment, it’s the supplier’s inventory and they’ll just come and pick it up, but the supplier has now protected their revenue and kept you as a customer.
If you are acquiring a company, identify the major suppliers. There are going to be opportunities to get major concessions from them or maybe even help finance the deal.
Factoring in the Accounts Receivable
One way the buyer would minimize their cash commitment would be to factor the accounts receivable and get cash today for a discounted value on the A/R. The value will depend on the credit-worthiness of the customers, but its rarely going to be more than a 5% deduction. You can then sell the A/R to a third party and get immediate cash within a few days. Let’s say you are acquiring a company in an industry that has a lot of customer credit, and there is $10 million in assets. Well, $5 million is probably in inventory and say $3 million is in A/R, with $2 million in equipment. There are several specialist firms who could factor (provide cash today for a discount on the value of their A/R). The result is you have $3 million extra at closing which you can use to fund the acquisition. If you want a local list of banks offering A/R factoring, give us a call.
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