Greig Rowand, head of corporate finance at Henderson Loggie. looks at sources of acquisition finance.
Q I am finance director in a manufacturing business. Despite the lean years, we have built up ‘rainy day’ money in the business My boss, the managing director, has just told me that ‘over a cup of coffee’ she has agreed to buy a competitor for £4 million. She wants me to “sort out all the detail and just make it happen”.
The ‘rainy day’ money is nowhere near £4m, and raising finance for these sort of acquisitions is really difficult, isn’t it?
Also, I’ve heard some bad rumours about this competitor and I need to get my boss to look at this acquisition in a methodical and structured manner.
What must I consider in terms of raising finance and paving the way for a successful acquisition?
A Before starting the finance-raising process, a business needs to be clear on a number of things:
* How much money do they need?
Businesses frequently underestimate their funding requirement.
Be prepared for potential funders to probe your assumptions about the amount needed and to ask ‘what if’ scenarios.
* Why do they need the finance?
A well as the acquisition price, you need to think about funding for the ongoing working capital of the target business, transaction costs, and likely capital expenditure in the next few years.
Funders like a well thought out strategy articulated in a concise and clear manner. Muddled, confusing and contradictory reasons for seeking funding make it too easy to say “no thanks”.
* What type of finance do they want, and for how long?
Assess whether you want to borrow the money or find an investor who will provide the funds, or a combination of the two.
Recently there has been a noticeable increase in the appetite of banks to provide business acquisition funding.
In addition, there are also other independent asset-based lenders (ABLs) who provide funding secured against the value of your business assets typically, trade debtors and stock.
Potential investors include business angels and private equity firms.
If you borrow the money the funder does not become a shareholder (as is usually the case with an investor), but the repayment timeframe will be relatively short (typically over two/three years); repayments will start almost immediately and you might need to provide some business assets as security.
Equity investment provides funding for the longer term, typically with no agreed timeframe for repayment of the funds. But, as investors don’t secure their funding against any of the business assets, they seek a higher level of return to reflect the greater risk.
Finally, in considering sources of finance, don’t overlook the businesses themselves improvement in working capital management (timely issue and collection of sales invoices, requesting better terms from suppliers) can often generate additional cash.
* How will the funder get their money back?
Banks (or other debt providers) will want to know how you are going to afford the repayments (capital and interest), and investors won’t want to be involved in your business forever, so you need an exit plan for them.
A business plan, along with financial projections (possibly for your own business as well as the target) can assist with this.
* It usually takes much more time and effort to raise finance than management thinks.
Professional advisers can help, but it is not a process that will happen without the involvement and commitment of you and your boss.
The acquisition
Turning now to the acquisition process, sit down with your boss and discuss the following five steps, which will help pave the way to a successful acquisition.
* Be clear on the strategic reasons for this acquisition; why the target is a good fit and how it is going to benefit and add value to your existing business. Potential funders need you to be able to articulate this.
* Draw up brief heads of agreement between you and the target company, summarising the principal commercial terms of the proposed deal.
These are not legally binding but are a useful way of teasing out any misunderstandings or ‘deal breakers’ without incurring substantial legal fees.
They also help clarify the structure of the proposed acquisition, including what you are buying shares or assets as well as how much of the price is being paid at completion and how much deferred.
The heads of agreement are also useful for preliminary discussions with potential funders.
* Can you rationalise the price of £4m, and how does it compare to the ‘going rate’ in the sector?
Think about the likely level of future profits from the acquired business (without the input and cost of the current owners), the value of the assets you will be acquiring, and the liabilities you are taking on.
What synergies are likely to arise from putting the two businesses together, and to what extent is the price based on ‘softer’ value drivers such as getting access to technology, skilled employees, IP, specific customers etc.
* You should undertake diligence (financial, legal and commercial) on the target business.
You might want further information because of a concern about taking on potential liabilities or reputational risk from certain activities of the competitor, or because the price is based on assumptions which, if invalid, would reduce the proposed price from £4m.
Funders are likely to input to the scope of the proposed diligence and review the findings.
* It is often said that what happens in the first 100 days after completion of an acquisition is critical to the success of the transaction.
To maximise the likelihood of success, you and your boss need to start developing the 100-day plan now, including areas such as IT and systems compatibility, implementation of cost savings, communication plan for employees in both companies, etc.