Acquiring another business is an extraordinary way to grow and develop your own business. Whether you’re improving economies of scale, developing your own services or introducing new ones, acquiring or merging with another business can offer several advantages.
But business acquisition financing is a tricky thing. While the rewards of business acquisitions can be tempting, the risks that come with financing the process can quickly overwhelm buyers who have not done their due diligence.
This guide will bring you up to speed on key acquisition finance strategies so that you can plan a strong acquisition strategy with measured risks.
Contact Nash Advisory for bespoke strategic and financial advice regarding your business merger and acquisition planning.
8 ways to finance your business acquisition
Caveat first: there is no ‘best method’ for financing acquisitions; each project has its own considerations and nuances that make it as unique as a thumbprint. Diligent and agile buyers will need to combine financing strategies to reduce their risk and boost the viability of the businesses they’re taking purchasing.
Let’s get into it.
1. Use company funds
Let’s start with the simplest, but rarest, method of financing a business acquisition: using your business's available funds.
The obvious downside to cash transactions is that you’ll be required to spend a sizeable amount immediately. Depending on the size of your business and the value of the target company, you simply may not have the cash on hand. It’s also worth keeping in mind what sort of investments you’ll have to make after the successful purchase of the target company; you may need to pay to improve its operations and bring it in line with your own business.
However, If you can afford to, you can purchase the target company outright without having to incur debt of any kind.
2. Use company equity
There are three ways you can use company equity to finance your acquisitions.
First, you have equity financing. By issuing new our new shares in your own company, you can raise the capital you need to complete your acquisition. The trick here is the weigh the value of the capital gained against the dilution of your control in your company.
Second, you have equity investment. By purchasing the majority of the target company’s shares, you can get yourself a controlling interest. This may be a more economical method of acquisition than a full buyout.
Third, you can offer the owner/s of the target company shares in your acquiring company. Sweetening the deal for them might induce them to lower the sales price of their business. Better still, by keeping them on hand (at whatever level you both agree to), you can continue to benefit from their expertise. You may also find that their continued presence offers an incentive for their managerial team and specialists to stay on after your business acquisition.
3. Get a bank loan
Easy enough; practically all major banks have loan products designed specifically for businesses, including business acquisitions.
Banks are an excellent source of capital as they have a vested interest in gaining or maintaining your business. Provide them with a thoroughly researched merger and acquisition strategy, and they may be persuaded to offer a more generous deal.
As with personal loans, banks require collateral for business loans. You’ll need to put your assets, or potentially your newly acquired assets, at risk to fulfil your debt obligation.
4. Use a leveraged buyout
A leveraged buyout (LBO) is a form of debt financing where your business will borrow the majority of the funds needed for the acquisition, usually from private equity firms, and use the target company’s assets as collateral.
Before considering an LBO, you should have a strong, clear plan for how you improve the purchased business to generate enough cash flow to service the loan. You’ll need to have plans to cut costs and streamline operations as soon as possible, as the size of the loan means you’ll likely be highly leveraged.
Failure to service the loan could mean the loss of your new acquisition.
5. Use an asset-backed loan
An asset-backed loan (ABL) is not entirely dissimilar from a leveraged buyout in that you will finance your acquisition primarily through debt and use assets as collateral.
But where an LBO uses the target company’s assets as collateral, the firm funding your ABL may require you to use your own assets as collateral. That may not be so steep a risk, as your assets are less prone to massive value fluctuations than your business is, especially during an acquisition.
The most important difference between the two strategies is that you would typically use an ABL to purchase another company’s assets rather than the company entirely. Essentially, rather than merging into one combined company, you’re mining the targeted company for what is most useful to you.
6. Find third-party financing
Third-party financing is the sourcing of acquisition capital from, well, third parties. If you own an SMB, then you may consider turning to a private equity firm rather than a bank as your third-party financier.
If you can gain their faith in the potential value of your acquisition, then private firms are likely to give you greater funding to complete the purchase. However, they may also have stricter terms. For example, an equity firm may stipulate that they be awarded a significant level of equity in the new business, and the board representation that comes with it. But that may not necessarily be a negative.
Find a third-party financier with relevant expertise in your industry, or your target business’s industry, or who has significant experience in mergers or other relevant processes, and you gain all of their expertise by bringing them on board. Nash Advisory has a strong network of connections that we may be able to draw on to find you an appropriate third-party financier.
7. Use mezzanine financing
Mezzanine financing can be a tricky strategy. It’s high risk, but it can be high reward, too. This strategy is favoured by companies that do not have the capital they need to fund their acquisition but also do not want to sell equity in their company.
Mezzanine debt allows lenders to create a loan with a unique conversion feature: if the borrower cannot repay the debt in cash, the debt can be repaid with equity in the borrower’s company.
You should consider mezzanine financing as a last-resort strategy, as failure to pay the loan can cause you to lose control of your company. However, if you can repay the loan, then you will have total ownership of the acquired company without having diluted shares in your own company.
As with all other forms of debt, preparation is the key to success, and you will need a strong financial advisor on hand to guide you past the pitfalls of the process.
8. Consider a joint venture
In a joint venture, you would pool your resources with another business to jointly take over the target business. This is a delicate strategy that requires diligent preparation to ensure you and your partner company are compatible.
The benefits of a joint venture are clear. You’ll have a far greater pool of funding to draw from to complete your business acquisition, and may even be able to afford to buy the target company outright. You’ll also have access to your partner’s unique expertise, and potentially even aspects of their business (depending on the terms of your venture.)
The risks, however, are just as clear. As partners, you will both have a say in the direction and operation of your newly acquired business. If you and your partner are not compatible or do not have a robust and clear joint venture agreement drawn up, then you are likely to get into irresolvable disputes down the road.
Trust Nash Advisory to help plan your business acquisitions
Now you know the key strategies for financing your acquisitions — but there are others. More importantly, fully and safely financing an acquisition may require you to utilise multiple strategies. Clearly, it can be a complicated process.