How to find the right financing structure for a business acquisition

Financing an acquisition requires adequately structuring the sources of capital while preserving the resources needed for the business’s operations and growth.

Buying a competitor, integrating a complementary business or entering a new market are all good reasons to consider an acquisition. However, the larger the transaction is in relation to your organization, the more carefully you should plan its financing.

Before approaching a bank or investors, ask yourself the following questions: are you paying a fair price for the target company? What level of debt can your organization sustain? How much capital will be required? And, above all, what financial flexibility will you have left after the transaction?

It is by answering these questions in advance that you will be able to put together a financing structure tailored to your project and your company’s long-term objectives.

What makes the purchase price so important?

A successful acquisition starts with the right price. A company may be an excellent strategic target, but the deal could well become less attractive if the price paid requires an overly aggressive financial structure or ties up too large a proportion of the buyer’s resources.

The valuation of the target aims to establish a value range based on market conditions and determine whether the proposed price is justified. It also helps to gauge the scale of the transaction in relation to your organization and its financial capacity.

For a medium-sized business considering a major acquisition, this analysis is particularly important. A transaction could be strategically appealing, but it risks weakening the buyer’s financial position if it requires too large a proportion of its cash or excessively increases its level of debt.

How should you structure the financing for an acquisition?

There is no one-size-fits-all structure. The optimal combination depends, among other things, on the buyer’s financial position, the size of the target, the stability of its cash flows and the shareholders’ objectives.

You can combine several sources of financing:

• senior debt, generally provided by financial institutions and which may be secured against the company’s assets;
• subordinated debt, which can supplement the financing and offer greater flexibility;
• an equity contribution from existing shareholders or new investors;
• seller financing (purchase price balance), which defers payment of a portion of the purchase price;
• a conditional price supplement (earnout agreement), whereby part of the price becomes payable based on the company’s future performance;
• seller reinvestment (equity rollover), where the seller retains a stake in the company following the transaction.

The cost of capital is obviously important, but it should not be the sole criterion. The chosen structure must also take into account the level of risk, the repayment terms, potential dilution for shareholders and the financial flexibility the company will need after closing the transaction.

What level of debt can your business sustain?

Before determining the financing structure, it is essential to assess the combined company’s debt capacity.

The aim is not necessarily to maximize the amount of borrowing available. Rather, it is to identify a sustainable level of debt that leaves the company with sufficient liquidity to meet its obligations, carry out its activities and continue to grow.

This analysis must take into account:

• available cash flows;
• debt repayments;
• working capital requirements;
• planned capital expenditures;
• various performance scenarios.

Why should you already be thinking about the post-acquisition stage?

Securing the necessary financing to complete the transaction is only part of the equation.

Once the acquisition has been completed, your company will need to continue paying its employees and suppliers, fund its working capital, make the necessary investments and absorb the costs associated with integration. It will also need to retain the capacity to seize new growth opportunities and cope with unforeseen events.

The best structure is therefore not necessarily the one that raises the most capital at the time of closing, but the one that meets the needs of the acquisition without compromising the business’s future.

How does financial modelling help you make the right decisions?

Financial modelling enables us to project the acquiring company’s results by incorporating those of the target company and to test different financing structures.

Each scenario can then be assessed in terms of its impact on debt, liquidity, cash flows and the company’s ability to continue investing.

In a recent assignment carried out by RCGT, a group was considering bringing in new investors to finance an acquisition. Our modelling, however, demonstrated that the combined company’s borrowing capacity was sufficient to complete the transaction without diluting shareholder interests or compromising its financial flexibility.

This example illustrates what a difference running various scenarios can make: the solution that seems obvious at first does not always turn out to be the right one.

Getting your financing application ready

Once you’ve determined the desired structure, you can present the project to lenders and investors who may be interested in participating in the transaction.

A well-prepared proposal should provide them with a quick overview of the company, the target, the strategic rationale for the acquisition and the organization’s ability to repay the loan.

Your structure should, in particular, include:

• financial projections;
• the key features of the transaction;
• the desired financing structure; 
• the company’s financial requirements following the acquisition.

Clear information and reliable projections make it easier to analyze the proposal and facilitate discussions with lenders and investors.

Securing adequate financing for an acquisition is therefore not simply a matter of obtaining the funds needed to complete it. The challenge lies in building a structure tailored to the transaction, preserving the company’s financial flexibility and creating the conditions essential for the successful integration and continued growth of the business.

Are you considering acquiring a business and want to determine how to finance it? Contact us!