The key reason for making an acquisition is to enhance shareholder value. Shareholder value will not be increased following an acquisition if the predator pays too much or fails to integrate the target business. A further acquisition driver is to acquire new, modern product or service offering at a time when yours is outdated. This latter point is of particular significance in the technology sector.
So what is stopping the typical small medium sized enterprises (SME) from going out and buying a business? Well, there are many barriers and challenges to be faced when entering the marketplace. The predator should first ensure their own business is running smoothly and efficiently. The predator must also ensure they have management capability to source and secure a deal and to be able to run the target business.
But, having ascertained the above factors are favourable, the major challenge will be money. How is the acquisition going to be funded? Listed companies will often issue paper in exchange for the targets shares. In the technology sector today, the likes of Google, Apple and Facebook are sitting on cash mountains that enable them to make multiple acquisitions fully funded by their own reserves.
But, for the typical SME the door is closed to the above routes.
The first point of call for funding will be the predator’s own cash reserves coupled with available headroom to raise cash against unencumbered assets, for instance receivables or property.
Next, the predator should review whether the target has free cash and/or debt can be used against the target’s assets such as property, plant, property, receivables, inventory etc. Raising finance against the targets assets is a form of financial assistance. Rules for financial assistance have been considerably relaxed but advice should be sought if this option is being used to ensure the predator does not fall foul of any legal or financial regulations.
So, having maxed out all available cash from your own and the target’s business, what do you do if you are still faced with a funding gap? It will come as no surprise that such a gap will often arise. The vendor will be looking for the maximum return whilst the buyer will be cautious not only not to over pay for what he is getting, but will worry about the future profitability of the target.
There are two key solutions to a funding gap
-Vendor loan notes
Vendors will often ask for money now based on the ability of their business to grow. An earn out recognises this and an earn out can be based on revenue/margin or profit targets going forward. Note that if an earn out is used, margin and profit numbers need to be clearly and specifically defined.
Vendor loan notes are becoming increasingly common. Vendors recognise that debt markets are not as freely available post financial crisis. Vendor loan notes may be for circa 30% of the total price and spread over a period of typically two to five years. The vendor needs to, where possible, obtain as much security as possible for the loan note.
In most cases, the longer term benefits of making a sound, well considered acquisition far outweigh having to face the challenge of a short term funding gap. The solutions are out there, and in the words of John Lennon ‘…it’s easy if you try...’