Financing mergers and acquisitions

For many businesses that want to grow the optimum route is through the acquisition of other businesses. Financing M&A activity can be an obstacle course, however, with funders keen to see the requisite due diligence has been done before agreeing to back any deal. Meanwhile, the sheer scale of the deals can often mean a mix of funding methods is necessary.

There is no magic formula in determining the right financing structure for a business or a particular deal, says Ciaran McAreavey, managing director of Close Brothers Ireland. “It is more a combination of factors and attitudes. Structuring a deal involves weighing up the respective costs and benefits of various types of debt and equity finance, and trying to strike the right balance.”

David O’Kelly, head of M&A at KPMG, explains that the cost of an acquisition is often larger than normal growth and the size of transactions can require that different avenues of financing are explored. “We have funded deals through a broad range of sources including senior debt, asset-backed loans, mezzanine finance, equity and vendor loan notes. The correct mix needs to be judged on a case by case basis depending on the risk appetite and priorities of shareholders and the working capital needs of the combined business.”

“Most forms of debt funding are cheaper than equity but increasing the amount of debt in a funding structure will come with an increasing cost, repayment terms, financial covenants, conditions and security,” says McAreavey.

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“Close Brothers can provide working capital and term debt facilities on a standalone basis and has successfully worked with other specialist lenders and equity providers to provide businesses with the complete funding package they require to complete an acquisition.”

Another factor in M&A funding is that it needs to be arranged at deal speed, O´Kelly adds. “Acquirers that are not sufficiently funded will find it challenging to get into pole position for attractive targets. As such there is much greater time pressure than might exist in a business-as-usual scenario.”

The process is complicated by the broad range of factors that funders seek to understand before signing on the dotted line and the depth of review will differ by the type of funding, O´Kelly says. “While debt funding will entail thorough preparation and diligence, equity funding is a riskier asset class and as a result has elevated diligence levels,” he says.

According to Robert Adams, managing director of Focus Capital Partners, the key thing that funders look for before backing an M&A deal for growth is the management team. “They normally look for ambitious management teams who have a good plan for the combined business and who have been successful within their own business.

“This plan can have synergies that can be taken from both businesses, opportunities for cross-selling within the merged businesses and much more.”

The levels of debt being used to acquire the business will be important to the funder, he adds. “There will generally be an element of equity required to complete the acquisition by the funder. This can be in the form of cash equity or it could be value built up within the existing business that is looking to acquire.”

Many companies and shareholders start with the assumption that they will debt finance M&A, he notes. “However, it is important to consider the restrictions that elevated debt places on a business and to be mindful of the risk appetite of shareholders. There is an abundance of equity options available in the market and most shareholders should be able to find partners that will help them meet their objectives.”

Stephen McCarthy, head of business development at Bibby Financial Services Ireland, says it is no surprise that M&A is firmly on the agenda for many Irish businesses at the moment. Recent research by Bibby Financial Service showed that 35 per cent of Irish SMEs were actively considering M&A, MBO or MBI activity in 2022.

Once restricted by a lack of options for funding growth, business owners can now look to fund growth through a variety of financial solutions. McCarthy says Irish SMEs are now actively looking for a hybrid mix of funding to fuel their M&A activity.

“What SME owners don’t realise is that they don’t have to give away equity, dilute their shareholding or take out a loan to fund growth – they could instead use a self-financing option such as invoice finance to facilitate the required growth,” he says. “Our research shows that just over one fifth (21 per cent) of Irish SMEs plan to use invoice finance to fund their M&A transactions, while just under a third are looking to fund these transactions with business loans. Many also tell us they just don’t want to have to take out a loan to finance a restructuring transaction.”

Invoice finance is a method of financing where a business owner is given access to any outstanding invoice amounts due – often in the millions – and this money can then be used to help fund transactions such as M&A, MBI or MBO’s. Several sectors are engaging in this activity to release equity to fund any executive transactions, include manufacturing, logistics, med-tech, advertising, recruitment, printing, professional services and hardware, McCarthy notes.

“This option obviously reduces the debt burden, provides additional working capital while also avoiding the need to give away any equity in the business. As well as providing the required liquidity to finance the initial contribution, it can then be used on an ongoing basis to provide essential working capital to allow the business trade-on successfully without any cash flow concerns,” he says, adding that Bibby Financial Services Ireland is now working with Permanent TSB to offer these and other funding solutions to businesses.

Corporate finance firm Crowe specialises in mergers and acquisitions for the SME sector. Naoise Cosgrove, managing director, says it is important to strategically review the range of options available to finance an acquisition by assessing the internal and external funding required. “This should be done at an early stage in the process.”

The funding landscape for business has changed significantly in recent years, he notes. “While historically, high-street banks were the main source of finance for M&A transactions, there are now a wide range of alternative lenders in the market. There is a vibrant private equity market with funds who are interested in investing alongside owners and their management teams.”

Some key factors that influence the type of funder to approach include the amount of funding required, the tangible security available, the level of gearing in the combined business, the repayment plan and overall growth prospects.

“Before embarking on the due diligence process you should build a strong and compelling business case for the purchase. It is important to outline the business plan for the acquisition, and how the integration will be managed, the synergies to be achieved and future growth prospects for the enlarged business,” Cosgrove advises. “The objective of the due diligence exercise should then be to gain a deeper understanding of the target business and ensure that it is as presented to you.”

Ultimately a funding partner will be examining the return that they can achieve from the investment and the level of headroom within the business plan, he adds. “If the funding is in the form of debt this will be influenced by the level of free cash flow generated by the business and the time horizon over which it is paid. For an equity investor the return will be assessed based on the credibility of the exit plan and growth targets for the business. An independent professional adviser should assist in presenting the relevant business case and navigating the funding market.”