How to Finance an Acquisition: Asset-based Financing
Asset-based lending has become an increasingly popular source of financing. According to the Commercial Finance Association, new credit commitments of asset-based lenders rose by 49 percent in the second quarter of 2010. Asset-based loans are revolving loans secured by the available collateral, such as inventory, accounts receivable, equipment, and fixed assets. The amount that can be borrowed is typically between 65 percent and 80 percent of the asset class.
The primary difference between asset-based lending and traditional lending is what the lender looks to when underwriting a loan, says Sherman. A traditional lender will look first to the cash flow then to collateral. An asset-based lender looks to collateral first, debt load, and quality of earnings. The main drawback of using asset-based loans for financing is the expense involved. Pricing among asset-based lenders is competitive, but interest rates can range from 12 percent up to 28 percent.
Dig Deeper: How to Find Alternatives to Bank Financing
How to Finance an Acquisition: Equity Financing
Equity financing involves the offer and sale of the buyer's securities for the purpose of raising the capital to pay the seller and to provide working capital for the new company. Typically the buyer seeks equity from such sources as private equity firms, venture capitalists, and angel investors.
Right now, most private equity firms are only interested in deals that have $2 million of earnings, generally $10 million dollars in revenues or above, Fekkes says. They are looking at middle market companies versus smaller mainstream companies. The owner has to be willing to give up a significant amount of control of the company, possibly as much as a 51 percent majority stake, he says. So, as a buyer you won't have any debt but you are going to have to give up equity for a cash infusion.
Also, private equity firms are expecting a rate of return of 25 percent. Each will have a different exit strategy and expectation, but in general they are looking to sell the business or take the business public in three to seven years.
Dig Deeper: How Private Equity Shops for Acquisitions
How to Finance an Acquisition: Mezzanine Financing
Mezzanine Financing is a hybrid of debt and equity financing. A mezzanine deal involves a number of technical terms: senior and subordinated debt, private-placement transactions and equity investment. Senior debt refers to loans from sources such as banks and secured by liens on specific corporate assets, for example, property or equipment. Equity is usually in the form for preferred stock. As a buyer, you won't have to give up as much control; it will look more like 20 percent ownership of the price of the target company, says Ronald A. Kahn, managing director of Lincoln International, an M&A advisory firm headquartered in Chicago. He notes that quite a few mezzanine groups have been sponsored by the SBA.
The size of the mezzanine finance industry has grown over the past year and is the only private capital market that is expected to increase in size, according to the "Private Capital Markets Project," conducted by the Pepperdine University Graziadio School of Business and Management. Deals that contain both interest rates and stock ownership return elements have increased 70 percent.
To get the best possible financing terms and improve the likelihood of success in any deal structure, make sure your offering memorandum or business plan is well thought out, says Kahn. "First impressions still count a great deal." Your plan should be based on the combined business not just the current business. It should illustrate how the combined operations will provide more collateral, more cash flow, and greater growth.
Going to a broader audience is really key to getting the acquisition deal done and at the best price, Kahn says. "When we do a placement it is not uncommon for us to submit an offering to 30 or 40 different lenders." He suggests as practical resources the Turn Around Management Association and the Association for Corporate Growth.
Dig Deeper: More on Mezzanine Financing
