The acquisition of another business is a crucial tactic companies use to expand their reach and fuel growth.
However, in your mission to acquire a business, finance is crucial. There are often substantial costs involved, which few companies will be able to cover through their existing reserves. You will need external funding to succeed.
Fortunately, there are many ways to raise funding for an acquisition. One such category is ‘leveraged acquisition finance’.
This blog explores leveraged acquisition finance and how it can help you in an acquisition scenario.
- What is leveraged acquisition finance?
- What are the benefits of leveraged finance?
- What to consider
- Alternative options
What is leveraged acquisition finance?
Leveraged acquisition finance refers to using debt funding (such as bank loans or other lending sources) to fund the acquisition of a company.
Simply put, finance is borrowed rather than coming from the acquirer’s reserves or shareholders.
Leveraged finance is used in many situations, including management buyouts (MBOs), management buy-ins (MBIs) and third-party acquisitions. Such an acquisition is often called a leveraged buyout (LBO). Leveraged buyouts are commonly used to acquire a company, take a public company private, sell a portion of an existing business or transfer property ownership (such as for a small business).
These scenarios typically involve a ratio of 90% debt to 10% equity.
Leveraged finance was commonly used in the early 2000s but experienced a decline after the 2008 recession. However, it has resurged in popularity in recent years.
What are the benefits of leveraged finance?
There are many reasons that an acquirer may use leveraged finance.
Many believe debt is cheaper than equity due to lower costs and share dilution. This is why some companies may use it for their acquisition goals to reduce the overall cost.
The main advantage of a leveraged buyout is it enables a company to buy a much bigger business than they would have been able to with their reserves, enhancing your growth potential.
By using borrowed funds, you only need a small portion of your assets whilst still being able to gain control of your chosen business.
What to consider
As with every form of funding, before committing to leveraged acquisition finance, there are things to consider.
You may need to involve your own or your business’ assets as security if you are taking out debt, especially at the significant levels required to cover an acquisition. You will most likely be able to use the assets of the target company you are acquiring, although this is harder in the B2C environment. Having this security reduces the risk to the lender, meaning you will secure higher sums and better interest rates.
It is important to produce detailed forecasts to ensure there is sufficient headroom and the affordability of these repayments required for the borrowed funding..
With private equity, they aim to increase their returns by creating high leverage (with much more debt than equity). This has led in the past to some companies becoming over-leveraged, where it is impossible to generate enough cash flow to manage the debt. It often leads to insolvencies or debt-to-equity shifts, where owners lose control. Avoid falling into this trap.
In the past, leveraged buyouts have been seen as method used by ruthless organisations. Due to the high use of debt, it’s possible to fund buyouts of businesses even if they are not necessarily looking to be sold or if another buyer would be able to acquire them without debt. The acquired company’s assets are utilised as security, meaning you use their premises, equipment, debtors etc., to secure lending.
However, this reputation has begun to shift as it begins to be used more commonly.
Alternative options
There are alternative options if you aren’t sure about using leveraged finance.
Firstly, you may use a lower proportion of debt. This reduces the gearing ratio for the business, which results in lower leverage. The corresponding affect is that debt repayments become more manageable, however you will need to bridge the funding gap.
One way to bridge this gap is via equity, such as angel investment, private equity and crowdfunding. You will need a strong business plan and the promise of a sizeable return on investment to attract investors.
You will also need to utilise any cash reserves you may already have. As mentioned, few companies will cover an entire acquisition this way, so you’ll likely need external funding.
Conclusion
Leveraged finance is one way to raise funding for an acquisition. It enables you to obtain a target company that fuels your growth strategy, even if you would not be able to afford it under different circumstances.
However, there are critical considerations to make. You must ensure you do not over-leverage any deal. It’s also crucial to have assets either in your company or the target company to secure the loans to maximise funding.
By understanding the implications, you should be able to create a financial structure that suits your needs.
If you are seeking funding for a business acquisition, we will pinpoint the best options for you.
We will also work with you to find the ideal target company and develop a long-term growth strategy to maximise your chances of success.