Raising Finance for Acquisitions
Surprisingly, most SME business owners (approx. 70%) only look to their bank when looking for a loan to acquire a business. (Source: British Business Bank).
There are two types of borrowing: Secured and Unsecured Borrowing. Unfortunately, in general, most banks do not support acquisitions for SMEs, unless there is additional security, personal guarantees and cash from either the Director(s) or company proposing the acquisition.
Secured borrowing
The cash to loan value of the proposed purchase price will normally determine the bank’s attitude to the proposal.
Banks, almost certainly, will only be interested in funding an acquisition if the proposer/acquirer has a history of success in a similar company or where the borrower is already established within the industry they are buying into.
And typically, where there is no cash, there is no deal.
Fortunately, the Alternative Finance Market takes a different view of experience and will take comfort if the new owner of the acquisition is competent to run the business. They will also take comfort if the management and staff have the experience in the company & market, to bridge any industry experience that the new owner may lack.
Using a lender in the Alternative Funding Market using multiple funding options, is usually a far more effective way to acquire a business, which will usually take place in the form of a Leveraged Buy Out (LBO) through the funding of assets.
An LBO is therefore, an acquisition that uses borrowed money i.e. “leveraging” or borrowing money against the assets of the business.
An asset for an acquisition loan does not normally include property. To leverage an asset, the asset must have a make, model and serial number and a date of manufacture.
It may be surprising to note that to use property as security, in nearly all cases, would need to be a domestic property. There are some lenders that will accept a commercial property, but the problem here is, should they have to foreclose, there are restrictions with the use of the property. A factory for instance, will only sell to a small market, meaning a more difficult sale or lower value. A domestic property however, will ensure a much greater loan to value ratio, as it is within a much larger market and therefore, much easier to sell.
In addition, a commercial property would need to be owned by the company and not the shareholder or their pension fund, which is often the case.
Most assets will have two values: a “market price” and a “trade-in” or “fire sale” price. The latter will be the value a lender will apply to the asset. In the case of having to foreclose, the lender will want a quick sale or may wish to auction the asset, so the lower value is what they are likely to receive.
Unsecured borrowing
It is still possible to obtain unsecured borrowing as part of acquisition funding. It might even be possible to achieve 100% borrowings for the acquisition, but very unlikely. This is mainly because unsecured borrowing is expensive, typically 1.5% to 2.5% per month, (sometimes up to 4%).
Some lenders will reduce the interest rate if the Directors offer some form of security, such as an equitable charge or even applying for a secured loan against their domestic property or rental properties that they own.
With acquisition funding, there is little chance of obtaining the funds for an acquisition without offering a personal guarantee (PG). If you are not prepared to offer a PG you are expecting a lender to take all the risk, in effect giving the company (your company) money with the Director or owner of the company, making ALL the company decisions, without a promise to pay it back.
Special Purpose Vehicle (SPV)
A company CANNOT borrow money and give it to the shareholders. THIS IS IMPORTANT. An acquirer will need another company, either their own existing company or a new one specially set up to do this transaction, known as a special purpose vehicle (SPV).
The process normally involves the target company borrowing the money from the lender.
The target company then lends the money to the SPV. The SPV then uses that money to pay the shareholders for their shares. The SPV and target company set up a loan arrangement as the SPV owes the target company the amount that was used to purchase the shares.
Please note that where financing a deal is concerned, no one deal is the same and that there are many options, variants and exceptions! For further help and advice on acquisition funding, simply complete the form below and we will put you in touch with our Finance Specialist (without any obligation):