Search
0203 327 0567

Exploring Leveraged and Acquisition Finance: Making Informed Business Purchases

In the world of business, growth and expansion often require strategic decisions regarding capital allocation and financing options. When considering a significant business purchase, two common approaches are leveraged finance and acquisition finance. Both of these methods enable businesses to access the necessary capital for expansion, but they differ in their structure and implications. In this blog post, we will delve into the concepts of leveraged and acquisition finance, highlight their differences, and explore why either option could be advantageous for your next business purchase.

Understanding Leveraged Finance

Leveraged finance refers to the use of debt, typically from banks or other financial institutions, to finance a portion of a business acquisition or investment. It involves leveraging the assets and cash flows of the acquiring company or target company to secure the necessary funds. Leveraged finance often comes into play during leveraged buyouts (LBOs), where a company uses borrowed money to acquire another company.

Key Features of Leveraged Finance

  1. Debt-Based Financing: Leveraged finance primarily relies on debt instruments, such as bank loans or asset based lending, to fund acquisitions.
  2. Leverage Ratios: These deals involve borrowing a significant portion of the purchase price, typically 60% to 90%, with the remaining amount provided as equity or cash from the target business.
  3. Collateralisation: The acquired company’s assets, including inventory, equipment, and intellectual property, serve as collateral to secure the borrowed funds.
  4. Repayment Structure: Loan repayments are made through the cash flows generated by the acquired business, allowing the acquiring company to service the debt over time.
  5. Risk and Returns: Leveraged finance can amplify both risks and potential returns. If the acquired business performs well, the returns on the investment can be substantial.

However, if the acquired business underperforms, the acquiring company may face financial difficulties.

Exploring Acquisition Finance

Acquisition finance, on the other hand, encompasses various methods used to finance business acquisitions. It focuses on obtaining capital to purchase an existing business, enabling the acquiring company to expand its operations, diversify its portfolio, or enter new markets.

Sources of Acquisition Finance:

  1. Equity Financing: This involves raising funds through the issuance of shares or equity investment from investors e.g. venture capital or private equity. It can be internal, involving the company’s own resources, or external, involving outside investors.
  2. Debt Financing: Similar to leveraged finance, acquisition finance may involve bank borrowing, asset based lending (using aged debtors, equipment or stock for example) or obtaining loans to finance the acquisition.
  3. Mezzanine Financing: This hybrid method combines elements of both debt and equity financing, providing the acquiring company with subordinated debt that includes equity-like features, such as conversion rights or warrants.

Key Considerations in Acquisition Finance:

  1. Financial Structure: The acquiring company must carefully consider the optimal mix of equity and debt financing to balance risk and returns.
  2. Strategic Fit: A thorough evaluation of the target company’s operations, synergies, and growth potential is crucial to determine if the acquisition aligns with the acquiring company’s strategic objectives.
  3. Dilution and Control: Depending on the financing structure, equity financing may result in dilution of ownership, while debt financing allows the acquiring company to maintain control.
  4. Post-Acquisition Integration: Adequate planning for integrating the acquired business is vital to achieve a seamless transition and maximise the value derived from the acquisition.

The Difference between Leveraged and Acquisition Finance

While both leveraged and acquisition finance involve securing funds for business purchases, there are notable distinctions between the two approaches.

Structure:

  1. Leveraged finance predominantly relies on debt instruments, leveraging the assets and cash flows of the acquiring or target company to secure financing. The debt is typically repaid using the cash flows generated by the acquired business.
  2. Acquisition finance, on the other hand, encompasses a broader range of financing methods, including equity financing, debt financing, internal funds and mezzanine financing. It allows for more flexibility in structuring the financing based on the specific needs and objectives of the acquiring company.

Risk and Returns:

  1. Leveraged finance carries a higher level of risk due to the significant debt involved. If the acquired business fails to generate sufficient cash flows or faces financial challenges, the acquiring company may struggle to meet its debt obligations, leading to potential financial distress.
  2. Acquisition finance, while still involving risks, offers a more balanced approach. By diversifying the financing sources, the acquiring company can mitigate risk and reduce its dependence on debt. Equity financing, for instance, provides a cushion of ownership and may offer better flexibility in managing the financial risks associated with the acquisition.

Ownership and Control:

  1. Leveraged finance results in a transfer of ownership as a substantial portion of the acquisition cost is financed through debt. The acquiring company may face dilution of ownership if sufficient assets do not exist in the target company, and lenders may impose certain conditions and covenants that restrict decision-making autonomy.
  2. Acquisition finance allows the acquiring company to maintain a higher degree of ownership and control, particularly if internal funds are the primary source of funding. By retaining a larger stake in the business, the acquiring company can shape the strategic direction and maintain decision-making authority.

Funding Availability and Cost:

  1. Leveraged finance relies heavily on debt financing, which requires a solid credit profile and collateral to secure the necessary funds. Lenders assess the financial health, cash flow stability, and asset quality of the acquiring and target company before approving the loan. The cost of debt, including interest rates and associated fees, can vary based on market conditions and the perceived risk of the transaction.
  2. Acquisition finance provides a more diverse set of funding options. Equity financing allows the acquiring company to tap into internal or external sources of capital, including private equity investors or venture capitalists. Debt financing, although still a component, can be structured to align with the financial capabilities and risk appetite of the acquiring company. Mezzanine financing bridges the gap between equity and debt, providing additional flexibility in funding the acquisition.

Choosing the Right Approach for Your Business Purchase

When deciding between leveraged and acquisition finance for your next business purchase, several factors should be considered:

Financial Position and Risk Tolerance:

  1. Evaluate your company’s financial strength, including cash flow stability, existing debt obligations, and creditworthiness. If your company has a solid financial position and can comfortably service additional debt, leveraged finance may be a viable option.
  2. Assess your risk tolerance and the potential impact of taking on significant debt. If your company prefers a more balanced approach with reduced financial risk, acquisition finance that incorporates equity financing may be preferable.

Strategic Objectives:

Define your strategic objectives for the acquisition. Consider the synergy potential, market expansion opportunities, and long-term growth prospects associated with the target company. Aligning these objectives with the appropriate financing approach will help maximize the value derived from the acquisition.

Funding Availability and Cost:

Professional Guidance:

Due Diligence and Valuation:

Integration and Execution:

Summary

Choosing between leveraged and acquisition finance for your next business purchase requires careful consideration of your company’s financial position, risk tolerance, strategic objectives, and available funding options.

Leveraged finance offers the potential for higher returns but carries higher financial risks and potential dilution of ownership.

Acquisition finance, on the other hand, provides a more balanced approach with a mix of equity and debt financing, allowing for greater control and flexibility.

Ultimately, seeking professional guidance, conducting thorough due diligence, and aligning the financing approach with your business objectives will help you make a well-informed decision and pave the way for a successful business purchase.

If business acquisition is the next part of your business strategy then talk to us.

We’ve been advising and working with businesses from many sectors with their business strategy – from the process of acquisition through to the debt structure to acquire a business.

Contact us today ….

Filed under: add_action ( 'om_the_article_category' );
|