M&A Financing Structure: 6 Types of Acquisition Finance
Jan 24, 2023
It’s rare for businesses to have the capital to purchase another business outright. Acquisition finance is the process of providing M&A funds for a company to purchase another company or acquire its assets. There are several types of acquisition finance available, each with its own advantages and disadvantages.
Types of Acquisition Finance Structures
Both the seller and the buyer need to consider the type of acquisition finance structure that best meets their needs. There are risks on both ends, and acquisition financial concerns must be weighed carefully when deciding which option is best.
In an ideal situation, both buyer and seller would have a balanced amount of risk, but as you read through the possible scenarios below, you’ll see that some possibilities may benefit one party more than others.
Acquisition Through Equity
Equity financing involves the buyer selling a percentage of their company in exchange for capital to fund an acquisition. This is a popular choice among early-stage companies, as it allows them to fund their growth without taking on debt obligations which may be difficult to manage due to volatile or low cash flow. In exchange for this flexibility, investors receive a share of all future profits.
Pros:
- Doesn’t involve taking on any additional debt
- Suitable for businesses without predictable cash flow
Cons:
- Equity financing dilutes ownership of the company
- There is no end period for paying off the investment, as there is with a loan
Acquisition Through Debt
Debt financing is when the buyer takes out a loan to fund the acquisition. This is an attractive option for buyers, as it does not require them to give up any equity in their business. However, interest costs and repayment terms should be carefully considered before committing to this type of financing. Buyers should be sure that they’ll receive a return on their investment that will allow them to repay their loan.
Pros:
- Buyer retains full ownership of the company
- Low risk for buyer as repayment terms are agreed upon upfront
- Interest costs from the loan may be deductible on your taxes
Cons:
- Buyer is required to take on additional debt in order to finance the acquisition
- Repayment terms must be adhered to, which could be a financial burden for the buyer
- Qualifying to acquire debt financing can be difficult
Stock Swap Transaction
A stock swap transaction occurs when the buyer offers their own stock shares at a predetermined rate to the seller in exchange for their company. This type of acquisition finance does not require any external capital and can be beneficial to both parties, as it prevents diluting either party’s ownership stake.
That said, this type of transaction can come with risks for the seller, as the value of the stock from the buyer may fluctuate based on the market and future company performance. Stock swaps can be used as full or partial consideration in an acquisition, meaning a buyer may choose to finance the acquisition with only stock or a combination of stock and cash.
Pros:
- No additional external capital is required to complete the acquisition
- Buyer and seller both retain their ownership stakes in the company
- Potential to combine with other financing structures
Cons:
- Complex stock valuation process must be accurately calculated (to determine how many shares of the buyer equals one share of the seller)
- Can create complexities with tax liabilities for both parties
Cash Acquisition
In a cash acquisition, the buyer pays for the entire purchase price in cash. This is one of the most straightforward forms of acquisition finance and allows the buyer to move quickly and confidently if they have sufficient capital available.
Pros:
- Allows for speedy completion of the transaction
- Buyer receives full control of the company once payment is made
Cons:
- Requires a large sum of cash up front, which may not be available for some buyers
- Typically used only when a large company is acquiring a smaller one
Leveraged Buyout
A leveraged buyout (LBO) is when the buyer uses a significant amount of debt capital to finance the purchase of an acquisition. The advantage of this type of acquisition finance is that the buyer can access large amounts of capital, allowing for larger or more complex transactions. Collateral for this type of arrangement can be secured from the borrower as well as the assets the borrower is seeking to purchase.
Pros:
- Provides access to greater funds, allowing for larger or more complex transactions
Cons:
- Buyer is taking on a large amount of debt, which can increase risk
- Likely only suitable for established businesses with predictable and reliable cash flow
Vendor Take-Back Loan
In a vendor take-back loan, or seller financing, the seller or vendor provides financing to the buyer directly by creating a loan agreement to allow the purchaser to buy the asset. Some portion of the purchase price will go to the seller at closing in cash, with the remainder repaid over a specified period of time and at a specific interest rate. This makes it easier for buyers to acquire businesses that they would not otherwise have sufficient capital to buy. It also allows sellers to receive some of their payment upfront while maintaining a lien on their business until they are fully repaid.
Pros:
- Buyer has access to funds for the acquisition that they may not have otherwise been able to obtain
- Seller can receive some of their payment upfront while receiving the remainder of funds over time
Cons:
- Interest payments must be made by buyer, which can be a financial burden
- Can create tax complexities for both parties if not structured correctly
Building an Acquisition Finance Model
Regardless of the type of acquisition finance structure chosen, it is important to build an accurate financial model that considers all aspects of the transaction, including the potential financing. This will help ensure that you understand the potential risks and benefits associated with the deal, allowing you to make an informed decision about whether or not to move forward.
Understanding the goals of both the seller and the buyer, the amount of flexibility needed, and the amount of risk desired will help you choose the right type of acquisition financing structure for a successful transaction.
Conclusion
When financing a business acquisition, it is vital to consider the various types of acquisition financing available. From equity and debt financing to stock swaps and vendor take-back loans, there are numerous M&A financing structure options that can be used to fund your acquisition.
By studying the pros and cons of each type of structure, buyers and sellers will be able to choose the one that best meets their needs. With careful consideration and an accurate financial model, business acquisition finance can be used to facilitate seamless M&A transactions.