Potential buyers can utilise debt when purchasing a business as it may allow them to maximise their investment and potentially enhance their returns. This is through a process known as leverage, where you may be able to finance a portion of the purchase price with borrowed funds (debt). A buyer can enhance their overall equity returns when the cost of debt is lower than the expected return on equity. If the business performs well, this can allow them to generate a higher return on their initial investment.
Buyers can utilise debt to:
- Increase their purchasing power: by using debt, buyers can increase their buying power and acquirer a larger or more valuable business than they could afford with their available cash alone.
- Enhanced returns on equity: when the cost of borrowing (debt) is lower than the expected return on equity, leveraging can amplify the buyer’s potential returns. This means that a smaller initial investment can generate a higher percentage return if the business performs well.
- Asset diversification: instead of allocating a significant portion of their capital to a single business, debt allows buyers to mitigate risk by spreading their capital across multiple assets.
- Preserving cash flow: using debt to finance a business acquisition helps preserve the buyer’s cash flow. Rather than using a substantial amount of their own funds, buyers can allocate their available cash for operational expenses, growth initiatives, or other investment opportunities. If the business that is being acquired includes tangible assets of substantial value, then these may also be financed to preserve cash flowfurther.
- Tax advantages: in some jurisdictions, the interest payments on business debt may be tax-deductible, reducing the buyer’s overall tax liability and improving cash flow.
It is important to note that while leveraging can provide these advantages, it also carries financial risk. The buyer is responsible for repaying the borrowed amount regardless of the business’s performance.
Using the example below, where a buyer has made an offer of $50m for a business that is making $10m EBITDA p.a. (assuming a 5 x EBITDA multiple); through debt the buyer can reduce the initial cash outlay from $50 million to $35 million. The purchasers return on equity in year 1 is then enhanced from 20% using no leverage, increasing to 26% utilising leverage, as the cost of debt is lower than the expected return on equity.
Nash Advisory are aware of instances in which buyers may be considering utilising debt. This is an important consideration as this can directly impact the valuation and offer received when selling your business, as the fair value of your business may be higher if leverage is to be utilised by a buyer.