12 Nov M&A Basics: Financing an Acquisition
Once you have decided how you are going to structure the buyout, whether you will do a stock purchase or an asset purchase, then you need to decide how you will finance the acquisition.
Unless a relatively large company is looking to acquire a relatively small company, most businesses do not hold enough cash to make an all cash purchase over the target company. In these situations the purchasing company needs to decide whether it will finance the deal through debt or equity.
There are many ways retrieve debt financing including a bond offering, a bank loan, or a promissory note. While a bond offering a bank loan are fairly straight forward, as in you borrow money from investors under an interest rate and then gradually or all at once pay those loans back in the future, a note is typically held by the seller. This simply means the seller does not liquidate 100% of the business in a signal transaction, but rather they hold some of the debt over a period of time. In these circumstances the seller will typically receive a higher corporate valuation on the business because he is taking on additional risk that would not be associated with an all cash purchase.
It is very common now days to see the seller take a promissory note that changes in value based on the performance of the business over the following 12 – 24 months. For example, if the future cash flows turn out to be higher or lower than what was forecasted then the note may fluctuate up or down depending upon how the two parties decide to structure the deal. This is especially common when the owners are under contract to remain with the company for a given period of time after the transaction is closed, thus ensuring the buyers that the old owners continue to have a vested interest in the company’s continued success.
Equity financing is about as straight forward as it sounds, you get investors to give you their money then you give them a piece of the stock pie in exchange for the investment. Usually an equity structure will set aside a certain percentage of ownership for the investors, a certain percentage for the management team, and a percentage for the entity buying the company. For example, if a company is making the acquisition with investors’ dollars then hiring a new management team to operate the company, all three parties will usually end up with some equity.
In some cases the existing management team and/or owners will stay with the company after the transaction, and as a result keep a large amount of the equity. In these circumstances they essentially participate in part of the financing. This is most common in mergers and rollups where the previous owners are expected to stay on board after the transaction. Again, they need to have a vested interest in the continued success of the company.
We work on financing companies all across the west coast, including mergers and acquisitions in Phoenix, Arizona.