How to finance an Acquisition ?

How to finance an Acquisition ?

Author: Joris Kersten, MSc

Kersten Corporate Finance: Selling & buying companies in The Netherlands (M&A). www.kerstencf.nl

Valuation training: 4th – 8th November 2024 @ Amsterdam South: Financial modelling, valuation and deal structuring. On top of that I provide inhouse training at leading institutes over the globe: New York, London, Hong Kong, Dubai, Saudi Arabia, Kuwait, Surinam, Peru, Mongolia. www.joriskersten.nl

Source used: Overname financieringen een inleiding. Tijdschrift Familie Bedrijven. Dhr. M.H. Stuker. February 2013.

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Introduction

When buying a company often a personal holding company is used.

The advantage is that when in the future the shares are sold, direct paying the tax authorities over the goodwill is not needed, and can be delayed.

Next to the personal holding generally another holding is set up to buy the shares.

This way a “fiscal unit” can be created with the “target company” in order to be able to deduct the interest expenses (to some extent) from the corporate tax.

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Forms of financing

Generally the following methods are used for acquisition financing:

1.?????? Bringing in personal money in the personal holding;

2.?????? Vendor loan of the seller;

3.?????? Dividends & financing from the target company;

4.?????? Bank financing.

It is common to finance an acquisition for a part on the target company.

Excess cash of the target company can be used for this, and the assets of the company can be used as collateral for the financing.

This is needed, because with acquisition financing also a part needs to be financed in the buying holding without any collateral.

So the assets of the target should be used to a maximum extent as collateral for the financing !

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The buying holding

As mentioned, in the buying holding there are generally no assets to back up the financing.

Of course there will be “a pledge on the shares”, but this will not mean much in case of a bankruptcy.

So basically we speak of “blank financing” in the buying holding, so no collateral.

In order to cope with this, there are some characteristics on this form of financing:

1.?????? Limited time period (e.g. 4-5 years);

2.?????? High interest;

3.?????? Covenants like non dividend payments, rules for paying back principal on vendor loans, personal guarantees etc.

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Cash flows & other conditions

The acquisition financing needs to be serviced with interest and paying back principal.

Here you need to focus on cash flows, so also take CAPEX (growth & maintenance capex) into account, and well as working capital requirements !

Next to cash flow analyses for debt servicing, the following components are very important:

1.?????? The buying entrepreneur/ party and his/ her/ their vision, experience, and personal financial commitment;

2.?????? The company itself and the industry;

3.?????? The valuation, enterprise value cash & debt free, and purchase price;

4.?????? Financial ratios.

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Concerning the quantitative aspects, the following components must be worked out carefully in order to successfully attract the acquisition financing:

1.?????? Personal contribution/ solvency;

2.?????? Collateral;

3.?????? Cash flow analysis;

4.?????? Ratios.

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The so called “guarantee capital” within an acquisition should be sufficient.

This for example is the personal contribution of the buyer, vendor loans by the seller, and maybe a financial sponsor that brings in equity.

This all can be seen as “solvency”.

As a very rough rule of thumb, this guarantee capital should be 20% to 50% of the purchase price.

Concerning collateral, the target company should be used to the maximum in order to use its assets, and excess cash, for the financing.

This in order to minimise the expensive blank financing in the purchasing holding.

Cash flow analysis also needs to be done carefully, and different scenarios need to be made !

Dot not forget to check and analyse “operating leverage”, so fixed costs in relation to variable costs.

Operating leverage is very important to analyse, I can not stress that enough.

(fixed costs are great when all is going well, because they are relatively cheap, but they can kill you when the business is going down, because they can not get rid off easily)

At last your ratios need to be checked:

-Net debt over EBITDA,

-Debt service capacity, and,

-Interest coverage.

For example, you can finance 3,5 times EBITDA in a certain industry for an acquisition.

Your debt service capacity needs for example to be at least 1,2.

This means you have a 20% “cushion” (1,2 -/- 1 = 0,2) to service the debt.

And your "interest coverage" needs to be 3 for example, as a general rule of thumb for a banker.

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I hope you found this article helpful.

See you next week again,

Best Joris????

Source used: Overname financieringen een inleiding. Tijdschrift Familie Bedrijven. Dhr. M.H. Stuker. February 2013.