Funding Acquisitions for SMEs
Funding acquisitions for small-to-medium enterprises (SMEs) is very much a function of the asset base being purchased, the relative size of the acquisition and risk profile of the target company. Funding options for an asset-intensive business are broader than a service-based business; however, the key area for proprietors to focus on is the risk to business cash flow. These risks may present in the form of revenue disruption/continuity or unidentified costs in a Due Diligence process.
Funding options available to SMEs include –
- Earn in/out structures
- Debt or Line of Credit
- A combination of the three
Again, depending on the relative size of the parties, combined Balance Sheet position, established bank/debt funding relationships and buyer and seller motivation.
The more common and risk-adjusted acquisition form of funding for SMEs is the Earn-in/out structure, where the combined business earnings capacity generates a substantial contribution to the purchase price over time. This approach has particular appeal to buyers as exiting owners remain exposed to business performance and risks not identified in the acquisition process.
Equity-funded acquisitions are largely dependent on buyer capacity and the ability to deal with lump sum incremental investment from existing sources of funds – either on Balance Sheet or via new investment. A key determinant of funding an acquisition on this basis should be risk and price paid given the absence of any continuity risk for sell-side owners in the future business performance. Alternatively, if strategic benefits are high, size is small relative to the acquiring business then on a risk-adjusted basis, this may be the most straightforward execution structure. For larger acquisitions, dilution and control issues require consideration.
While debt-funded acquisitions can be a viable option, it is generally dependent on having an established relationship with a financier. Key determinants in the use of debt funding for acquisitions lie in the stability of business cash flows and risks from costs not identified in the due diligence review of the target – interest rate changes, staff, compliance, tax, customer, and supplier to nominate a few. SMEs also need the requisite systems and controls in the business to manage a debt facility including reporting requirements of lenders. Importantly, debt facilities should be structured to meet the needs of the business – working capital, asset/equipment or general term debt facilities.
If you are contemplating an acquisition or raising debt facilities to grow your business or looking for a deeper dive on the points above, contact us here.