M&A Financing Do’s and Don’ts
By Ken Haffey, Partner, Advisory Services
The road to victory in the acquisition game is not always a smooth one. Along the way, you’ll hit bumps, slick patches, possibly some potholes—and there are lots of opportunities to detour down alternate paths that may or may not prove wise.
The laundry list of potential acquisition-related considerations is, as you might imagine, quite extensive. In this blog, we will explain some of the key considerations related to pursuing and securing financing; highlight current financing trends and how those affect borrowers; offer practical advice to position yourself and your acquisition opportunity favorably in the bank’s eyes; and warn you about common pitfalls, as well as suggestions to steer clear of them before they occur.
Strategy #1: Avoid ambiguity—be clear, transparent, thorough and genuine. If you’re pursuing an acquisition, you’ll most likely need lender financing, and the financial institution from which you hope to obtain funds will want detailed information about your plans. They’ll want to know seemingly everything—from why you’re attempting to acquire, to what you’re attempting to acquire, what that acquisition will accomplish and more. Yet really, these questions are all different ways of asking one key, bottom-line question:
How and when will we get paid back?
Seems simple, but banks are in the business of lending money, and getting it back with interest. In this regard, Strategy #1 is also Priority #1. You must be able, through whatever means necessary, to tangibly provide to the bank where the money will come from to service the proposed debt you are asking to incur. While that may seem obvious, it’s shocking to us how many potential buyers fail in this most fundamental of challenges.
Strategy #2: Gauge your tolerance for risk—but don’t avoid it completely. By its very nature, acquisition inherently involves risk—and if you’re the one working the deal and standing to benefit from an acquisition, you must assume your proportionate share of risk. No lender of sound mind or repute will agree to financing terms if you aren’t willing to put some skin in the game. After all, if you don’t believe in the deal, why should the lender?
So how do you determine the proper amount of risk? According to Pat Rositani, President at Lake Credit, start with 10 percent of the financing request and work upward. It’s best to consult with a qualified financial advisor who is experienced in transactional work and has the depth of expertise and insight to provide valuable answers.
Strategy #3: Come to the table prepared. Again, your potential lender wants to know how and when it will get paid back. You need to provide realistic answers, and that starts with a realistic view of what you intend to buy—including historical, current and prospective cash flows, outstanding debt, quantitative and qualitative insights into current customers, external market information, and so much more. Banks also want to know about you, your financial track record, and what kinds of liquid assets you possess on both sides of the business. All this is a way of saying, do your due diligence up front; be thorough about it; and be prepared to discuss your financing request in exhaustive detail with the bank so that its representatives are clear in their understanding of (1) how the business works from a financial standpoint, and (2) how and when they will get paid back.
One note: As part of your due diligence, we recommend conducting a “status quo versus growth by acquisitions” analysis. While the bank may have one core question it needs answered, you do, too, and that question is, does it make more sense to undertake the acquisition or maintain the status quo?
There’s also the question of cash. When you approach a lender for financing, you must be prepared to put a percentage of cash into the deal. In this regard, it’s essential that the cash be just that—cash. In other words, it must be accessible. For example, money in a trust to which you currently have no access is not accessible cash. If someone tells you otherwise, it may be in your best interests to look elsewhere for advice.
Strategy #4: Be patient, and don’t disengage as the bank works through its process—at its pace. Again, it’s a process, so don’t panic. It may take more time than you hope it will, but that’s not necessarily a bad thing. The bank is conducting research, educating itself on your business and doing its due diligence to help ensure the fit is a good one. That benefits the bank, and all parties involved, including you. In fact, coming back too soon could be a bad thing if too many red flags are spotted early on.
Strategy #5: Understand current lending trends—and act accordingly. According to Pat, banks are starting to loosen their purse strings and seek deals in the wake of several post-recession years that saw a dramatic decrease in deal making. For years leading up to the Great Recession, banks made it a bit too easy for borrowers to secure funds—including many who weren’t qualified. Lenders looked for reasons to do deals, and often, they overlooked many obvious red flags. Once the effects of the recession hit in full force, the pendulum swung the other way as most banks took a stridently conservative approach toward lending. In other words, they looked for reasons not to do a deal. While we’re not back to “normalcy” entirely, the lending environment is indeed somewhat more borrower friendly than just a few short years ago. That said, Strategies #1, #2 and #3 apply just as much today as they ever did.
So, as you can see, acquisition isn’t rocket science. Beyond the requisite tasks of dotting Is and crossing Ts, it really comes down to conducting oneself as a detail-oriented, conscientious business person who can make a rock-solid case for what is being requested.
Do you have questions about M&A markets, developing an M&A strategy, or are there other transactional challenges you face? Please contact Ken Haffey, Partner, Advisory Services.