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Understanding Business Acquisition Financing

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At the simplest level, business acquisition financing is the capital that needs to be obtained for a company to purchase another business. This finance can be in the form of equity, debt or a combination of several financial solutions that get them the funding required to pursue the purchase of another business. 

Why do Businesses Make Acquisitions?

Acquiring other businesses is common practice for companies for a variety of strategic reasons. Most of these reasons relate to boosting business growth; from enhancing competitiveness to entering new markets, business acquisitions offer a number of potential benefits, including;

  • Diversification – Acquisitions allow businesses to diversify their product or service offerings which can help mitigate the risks associated with being too reliant on a single product or market segment. Diversification can also create opportunities for upselling and cross-selling to the existing customer base, therefore increasing revenue and profit. 
  • Strategic Expansion through Talent, Technology or Expertise – Acquiring another company can help a business expand its market presence quickly as they gain immediate access to the customers of that new business. It can also give them an in-route into new geographic regions or complementary industries which can all lead to increased market share. Acquiring a company that has specialized technologies or intellectual property can accelerate the development of key new products and services. The acquired company may also come with a pool of skilled and talented employees who can contribute to the business’ innovation and expansion. Acquiring a company to enter into new markets can often be more efficient and cost-effective than starting from scratch as they already have established operations and a network of relationships. 
  • Cost Savings – Through economies of scale, sharing of resources and reduced inefficiency in operations, businesses can realize cost-savings and increase profitability. 
  • More Market Power – In saturated industries with an abundance of small players, acquisitions can help the acquiring business to strengthen their position in the industry. As the market consolidates, competition is reduced and the business benefits from great market share and more buying power. A business could make the strategic move to acquire a competitor in order to eliminate its competition.  
  • More Certainty – In an uncertain world and economy, acquiring companies that are either upstream or downstream along the supply chain, can give a business greater control over sourcing, distribution and quality which may lead to cost savings. 
  • Financial Performance – A business acquiring a company that is financially distressed or undervalued has the opportunity to improve its overall financial performance by turning around the acquired business’ assets. In certain cases, acquisitions may provide tax benefits or opportunities for more favorable financial structures. 
  • Brand Enhancement – Acquiring a more well-known and respected brand in the industry can increase your business’ brand visibility and reputation, with the potential to attract more clients and create positive associations in the process.

So, although there are prolific benefits to business acquisition, some SMEs will be unable to capitalize on acquisition growth opportunities as they are frequently rejected by the banks.  

How do you Finance a Business Acquisition?

A conventional bank loan is one route to financing a business acquisition but certain industries will have a tough time qualifying as they either don’t have enough traditional assets to present as collateral, or the business they’re acquiring is not profitable enough; they may have a more complex recurring revenue model or be challenged by all of these things. In any case, they likely won’t be ideal candidates for more stringent bank loans or lines of credit from a main street bank. For the same reasons a Small Business Administration (SBA) loan is generally out of reach too. 

Assuming that regular debt finance is unattainable, what are some other ways to fund a business acquisition? The best way to finance a business acquisition will depend on various factors including the financial health of the acquiring company, the target company’s valuation and size of the acquisition plus the strategic goals of the business buying. Here are some alternatives to bank finance;

  • Equity Finance

In terms of business acquisition, equity finance entails the company selling shares in the business to raise capital and sharing their profits with the investor for an unspecified period. Equity capital is considered one of the most expensive forms of capital and business owners will most certainly relinquish some control over its decisions and operations to any new shareholders. 

  • Cash Reserve

Making an acquisition outright with cash is a straightforward option for businesses that have substantial cash reserves. For most businesses however, this won’t be an option as it depletes cash resources and hurts cash flow.

  • Alternative Debt Finance

Debt finance is typically regarded as one of the cheapest ways to fund a business acquisition, even when bank finance has been ruled out. Very few companies will be able to purchase another business with cash and even if they had the cash, it’s often not an option due to longer-term cash flow considerations. 

Some primary forms of debt finance include non-bank cash flow loans and asset-based financing. A cash flow loan provides access to funds based on historical or projected cash flow. Unlike a traditional bank loan that heavily considers trading and credit history and available collateral, a cash flow loan from an alternative lender focuses primarily on the cash flow generated or estimated to be generated by both the acquiring and the target business. 

Non-bank cash flow loans have more flexible qualification criteria, making it easier for businesses with unique circumstances or less established credit to qualify for them. They should also have a quicker turnaround time and more flexible repayment terms based on the business’ usual cash flow cycles. Cash flow finance enables businesses with limited tangible assets to access funding for expansion such as the acquiring of another business. 

Asset-based finance is a type of debt finance that involves using specific assets as collateral to secure a loan. These assets might be real estate, equipment, inventory, accounts receivable or other items of value owned by the business. Similar to cash flow loans, while asset-based finance is a form of debt, it differs from traditional term loans or credit lines in that the lending decision is frequently based more on the borrower’s creditworthiness and the value or the assets being used as collateral. This can make it a viable option for businesses with strong assets but less encouraging credit profiles. 

In a business acquisition, asset-based finance can be secured on either the acquiring or the target business, or a combination of the two, depending on the assets being used and the terms of the financing agreement. 

If the acquiring business has valuable assets that can be used as collateral, the asset-based finance could be secured on the acquiring business itself. This approach is common when the acquiring business has a strong balance sheet and assets that can be leveraged to secure the financing.

In certain cases, the asset-based finance might be secured on the assets of the business being acquired. This can be particularly relevant if the target business has more valuable assets than the one acquiring. Lenders may be able to assess the value of these assets to determine an amount of financing they are willing to provide.

It’s also possible for the asset-based financing to be secured on a combination of assets from both the acquiring business and the target business. This approach can be beneficial if the assets of either business alone do not fully meet the lender’s collateral requirements, but the combined assets provide sufficient security.

Business Acquisition Financing:  A Bespoke Package

Before entering into a business acquisition, it’s crucial to conduct thorough due diligence on the business you intend to acquire. You’ll also need to work closely with financial advisors and legal professionals to ensure that you make an informed decision and that the financing is structured in such a way that it aligns with your goals and risk tolerance. 

Business acquisitions can be complex and no two situations will be the same. While a new bank loan for the specific purpose of acquisition can be problematic for many businesses, finance solutions are not mutually exclusive. More often than not, one or more finance options need to be used collectively to achieve the required level of funding for a business acquisition. 

It’s essential to understand the terms, fees, interest rates and repayment structure for any financial solution before entering into an agreement. Working with financial advisors will help ensure that any finance arrangement aligns with the business’ financial needs, capabilities and long-term goals. Whatever the financing mix, getting the optimal financial structure will be critical to ensuring a smooth and efficient transfer of ownership and integration, and positions the business for success in subsequent years. 

For more information on the sources of finance available to you for a business acquisition, please reach out to our team. 

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