One of the striking features of the period since the COVID pandemic took hold is that M&A activity involving our clients has remained strong. The factors driving M&A have remained resilient despite the pandemic, and businesses have managed to adapt to the changing business environment. In addition, the pandemic has given rise to opportunities to make business acquisitions, including of distressed businesses which sadly have been badly affected by the pandemic, as well as of new and existing businesses which have successfully adapted to the new environment. We expect that M&A activity will remain strong as lockdown measures continue to be relaxed, and buyers seek acquisition opportunities.
Why buy a business?
There are a number of reasons why a business would acquire another, rather than growing organically. Acquiring another business can provide immediate access to a market or build a market presence, the acquisition may result in economies of scale for the combined business, and in certain cases an acquisition can be a means of eliminating completion. An acquisition strategy enables a business to grow more quickly than it might do organically.
How will the acquisition be paid for?
Some buyers are in the happy position of having sufficient cash to fund fully a business acquisition. This may be achieved by a single payment on completion of the acquisition, or by partly deferring part of the cash payment, the amount which is often dependant on the future profitability of the acquired business (known as an earn out). In other circumstances, the seller or sellers may wish to have a continuing interest in the business sold, in which case they may accept payment by way of the issue of shares (equity) in a buyer company in part payment, or full payment in the case of a merger of the businesses.
If the buyer is a listed company, then a seller of a business is likely to be more willing to accept the buyer’s shares as payment, as they can be traded on a stock exchange. This can take the form of a reverse takeover, whereby selling shareholders accept shares in the listed buyer company in full payment, with the result that they hold the majority of shares in the listed buyer. Listed companies are also able to fund acquisitions by issuing shares for cash to institutional and other investors, so that the resultant funds can be used for payment.
Both listed and private companies may though need or prefer to fund an acquisition by taking on debt. This can be attractive as it avoids the dilution of the equity in a buyer company which results from issuing shares as payment or to raise cash, and may be a relatively cheap way of raising money, if interest rates are low.
There are many different types of borrowing that are available, including the following:
a well established and profitable business may be able to obtain a secured term loan, which would take priority over other unsecured or junior debt. Such a loan is likely to have a relatively short term (up to five years) and may have a fixed or variable interest rate. The assets of the buyer can be used as collateral, or instead of physical assets the loan can be secured on the buyer’s cash flows.
specialist lenders will provide mezzanine debt, which is a loan that can be converted into shares in the borrowing buyer company in certain cases, including the buyer’s default. There is a great deal of flexibility as to the way it can be structured. Mezzanine debt is typically subordinate to senior debt but ranks ahead of equity in the borrower.
Asset Based Lending (ABL):
the assets of the target business as well as of the buyer can in certain cases be used as collateral for a loan, and these can include property, plant and machinery, other fixed assets, inventory and receivables.
: these are debt instruments providing for repayment of the amount borrowed at a future date and the payment of interest on the amount borrowed. As these can be technically complex to issue, they are usually issued in tradeable form by large companies to raise significant amounts.
The above methods in various forms can be used to finance acquisitions by one business of another or management buy-outs or buy-ins, where the management acquire a company or its business from the owners by using third party funding, in some cases private equity funds which typically make an equity investment.
The use of third party debt can increase the complexity and timetable of an acquisition, and buyers must expect the lenders to require access to the due diligence carried out on the target business and to carry out their own due diligence on the buyer.
Structuring the acquisition financing
It is important that the financing for the acquisition is carefully structured to align with the nature of the transaction, the buyer’s plans for the combined business and its ability to service the debt that is assumed going forward.
Although the costs of debt finance are often preferred to the dilution of equity resulting from offering shares in a buyer company as payment, a buyer’s ability to fund an acquisition through debt will depend on its ability to meet the interest payments and capital repayments without disrupting future cash flows, and also on the strength of its asset base. Taking on a large amount of debt is generally more appropriate for mature businesses which have steady cash flows and don’t have a need for significant future capital investment. Fast growing and capital intensive businesses, or businesses that operate in unstable markets, will more likely consider equity financing.
There are multiple sources of funding available, including clearing banks, smaller boutique banks, specialist lenders and finance providers and private equity firms, offering a range of financial facilities and products, involving debt, equity or a combination of both.
How we can help
DMH Stallard’s corporate and finance teams have significant experience of advising buyers and sellers involved in business acquisitions, both in the sphere of private M&A and on the capital markets, in relation to the transaction and the method of financing it.
If you are considering a business acquisition and would like to discuss any of the above methods of financing or to be introduced to a potential third party funder, please get in touch with your usual contact at DMH Stallard or Nick Williams
or by phone on 020 7822 1523.