Funding a Business Acquisition

Written by Marcus Hill
May 8, 2024
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Acquisitions, Funding, Mergers

Acquiring or merging with another business is significant for business owners seeking growth and development.

However, securing funding for a merger or acquisition can be overwhelming without proper understanding and assessment.

In the video below, Elements Advisory Group partner Marcus Hill explores the top 5 different ways business owners can fund an acquisition. In this article, we have added some honourable mentions.

It’s important to understand there is no ‘best method’ for financing acquisitions, as every transaction is unique and requires its considerations.

Business Acquisition Funding Methods

Using Company Equity

Issuing new shares or leveraging existing ones can inject capital to fund an acquisition.

Offering equity to the target firm’s owners can be a strategic move to maintain expertise and retain key personnel post-acquisition.

Alternatively, you can get a controlling interest by purchasing most of the target company’s shares. This may be a more economical method of acquisition than a full buyout.

Securing a Bank Loan

Traditional yet reliable, securing a bank loan provides immediate capital, but rigorous due diligence and collateral requirements are essential. Interest rates and repayment terms can significantly impact your overall cost of capital.

It works similarly to secured personal loans, where you must provide an asset to guarantee the loan, such as a vehicle, savings account, or term deposit.

A well-researched merger and acquisition strategy can sway banks to offer more favourable terms.

Opting For a Leveraged Buyout (LBO)

The leveraged buyout or LBO involves borrowing a significant portion of the purchase price, using the target company’s assets as collateral.

While it amplifies returns, it also magnifies risks and debt levels.

Before considering an LBO, you should have a clear plan for improving the purchased business to generate enough cash flow to service the loan.

Seeking Third-Party Financing

Involving external investors or financial institutions can diversify risk but requires relinquishing some control. Private equity firms might be a viable alternative to banks for small and medium-sized businesses; however, they may also have stricter terms.

Private equity firms generally also have a more aggressive timeframe to make a return on their investment and will also want to take some form of control at a board level.

Third parties assist in providing additional funding and potential network benefits, so finding the right partners is important.

Considering Mezzanine Financing

Mezzanine financing is a hybrid between debt and equity.

It allows for flexibility in the repayments, making it an attractive option for funding an acquisition. However, the cost of capital is higher, and lenders often demand an equity stake or warrants.

In most cases, these hybrid-type options also have some convertible debt-to-equity feature, meaning that the debt can be converted to shares at some point in the future, generally for a pre-determined strike price.

You should be careful when accepting this type of finance due to the risks of losing control of your company in the event the future conversion of debt to equity gives the loan provider a controlling interest.

It should be a last-resort strategy due to the risk of losing control of your company in case of payment failure.

Honourable mentions

Using Company Funds

Using Company Funds is the most straightforward method for funding an acquisition and yet the most rare. Leveraging existing resources may be prudent; however, you would require a large amount of capital.

Using company funds has the benefits of preserving ownership and avoiding external debts. Still, this method may limit the scale of acquisitions and necessitate careful budgeting to incorporate post-acquisition investments for operational improvements.

Employing An Asset-Backed Loan (ABL)

ABLs tie financing directly to the company’s assets, offering flexibility. Asset valuation and maintenance are critical, and your assets might be used as collateral.

This means the value of your assets determines the funds you can secure.

Typically, ABLs purchase specific assets rather than the entire company. So it’s like buying assets from assets.

Exploring a Joint Venture

Joint ventures present an opportunity for two companies to collaborate and share the risks and resources involved in the acquisition. These partnerships can significantly enhance a company’s capabilities and expand its market reach.

However, successfully aligning goals and effectively managing the joint venture requires thorough and meticulous planning.

The equity distribution in the acquired business can influence decision-making authority within the partnership. Ensuring compatibility between the collaborating companies and a shared vision for the venture’s objectives is crucial.

Choose a Method Best Suited To Your Circumstances

Each method has its considerations and nuances, making it crucial for diligent and agile buyers to combine strategies to help mitigate risks and ensure successful acquisitions.

Careful planning, thorough due diligence, and an understanding of the funding options available are crucial when venturing into the world of mergers and acquisitions.

At Elements Advisory Group, we guide you through the whole M+A transaction end-to-end, including the years following earn-out agreements. We can help you understand the best way to fund your next business acquisition and assist with the necessary Due Diligence and planning to ensure your funding decision is right.

To discuss your options for a merger, acquisition, or valuation requirements, contact us today at admin@elementsag.com.au or 07 3878 9181.

Thanks for watching, and good luck with your business journey.

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