Mergers and acquisitions can benefit businesses in many ways, as they can help companies drive growth, acquire new knowledge, improve their output and move into new markets. However, financing this type of deal can come with its challenges, resulting in the need for innovative funding solutions.
Explore the different ways businesses can fund mergers and acquisitions to help you find the best solution for your enterprise.
What Is M&A Financing?
M&A financing is the process of funding the consolidation of two companies through various financial transactions. These transactions often require a considerable amount of capital. Aside from the company’s existing cash reserves, the primary source of funding is debt or equity financing. The capital can be used independently or collaboratively to fund merger and acquisition transactions.
How to Finance a Merger or Business Acquisition?
The following are a few of the different ways to finance mergers and acquisitions:
Using your company’s equity to finance a merger or acquisition is an excellent option for avoiding mandatory interest and loan repayments. When the merger results in a newly formed company, shareholders from both companies will own a stake in the new business.
Cash on Hand
If your company has a significant amount of cash on the balance sheet, you can fund the acquisition without any outside capital. Financing an entire purchase may require years of saved-up profit depending on the company’s size. With this option, you will likely want to consider a hybrid financing solution to offset lowering your company’s liquidity.
Banks often have provisions for M&A financing loans. However, they will look at factors such as the company’s industry, past cash flow trends, possible assets that can be secured, and more before approving the loan.
A SBA loan is a straightforward way of financing an acquisition. With this loan, you can borrow up to $5 million, which is ideal for purchasing a small-to-midsize business. If your company meets the set requirements, you can access a loan with a competitively priced rate, comfortable loan structure, and other favorable funding terms.
An asset-backed loan is a powerful tool in the financier’s arsenal, especially used when a company looks for ways to fund mergers and acquisitions. Essentially, this is a type of loan where the borrowing company’s assets serve as collateral to secure the loan. In the event of non-payment or default, the lender has the right to seize these assets.
What makes it attractive as a funding solution for many businesses is the wide variety of assets that can be used as collateral, including:
- Company Property: This includes land, buildings, or any physical property owned by the company.
- Inventory: Items that a company produces or purchases with the intent to sell also fall under this category.
- Accounts Receivables: This includes money owed to a company by its customers. Some companies choose to use their receivables as collateral for an asset-backed loan.
- Intellectual Property: Certain lenders may also accept patents, trade secrets, copyrights, and trademarks as valid forms of collateral.
Utilizing an asset-backed loan, businesses can potentially unlock immediate liquidity.
Navigating the Pitfalls of Traditional Funding Methods
There’s no denying the role that traditional sources of financing have played in enabling countless mergers and acquisitions. Time-tested and well understood, methods such as bank loans or using a company’s own cash reserves have been instrumental in many successful M&A activities. However, it’s important not to overlook their potential drawbacks. Let’s pull back the curtain and glance at some of these elements that often remain in the shadows:
- Interest Rates: It’s no secret that borrowing funds often come with an interest rate. While it might seem manageable at first glance, these rates can be burdensome over the course of repayment, especially during financial downturns.
- Stringent Requirements: Securing a bank loan can often resemble running a gauntlet. They tend to have rigid prerequisites, such as a robust credit history and substantial assets. Every box needs to be ticked, and falling short could put the brakes on your M&A process.
- Risk of Debt Accumulation: Borrowing comes with a shadowy companion – debt. Depending on the amount borrowed and the terms of repayment, this debt can have a significant influence on the company’s financial future and can potentially restrict growth prospects.
- Dilution of Ownership: Equity financing, while avoiding debt, invites other guests to your ownership table. This can mean the distribution of control and diluted authority, which may not sit comfortably with all businesses.
- The trade-off with Cash Reserves: Using cash reserves may seem like a handy solution, but it’s much like spending your savings – handy but leaves you unprotected. It also requires the firm to generate and retain enough cash, a feat not always achievable for everyone.
Clearly, sticking solely to traditional funding methods is akin to keeping all your eggs in one basket. Understanding these potential limitations underscores the necessity of considering more novel, innovative funding solutions. These newer options could provide the flexibility, agility, and resources crucial to navigating the ever-evolving landscape of mergers and acquisitions.
Choosing the Right Funding Solution
When it comes to selecting a funding solution for mergers and acquisitions, there isn’t a one-size-fits-all solution. Different businesses have varying financial needs, resources, and strategic objectives. Understanding your unique situation and long-term strategic goals is key to selecting the right funding solution. Here are some factors to consider:
- Cost of Capital: Understand how much the funding will cost you in the long run. This includes interest rates, potential equity shares, and other costs associated with different funding solutions.
- Time Sensitivity: Certain funding solutions are time-consuming to set up and may not be suitable for M&As that need to be completed swiftly.
- Risk Tolerance: Every funding method comes with its own set of financial risks. Weigh those risks against your company’s risk tolerance levels.
- Financial Position: If your company has strong cash reserves, it might be more logical to use those funds instead of accumulating more debt or diluting company ownership.
- Strategic Compatibility: Choose a funding solution that aligns with your overall strategic goals. For instance, if your strategy involves rapid expansion, debt financing might be counterproductive.
One cannot overemphasize the importance of obtaining professional legal and financial advice when making these decisions. Lawyers, accountants, and financial advisors have the professional expertise required to scrutinize offers, anticipate potential problems, structure deals, and guide you through the complexities of funding options. Their knowledge and insights can save you from potential pitfalls, ensuring your M&A transactions are both profitable and compliant with legal standards.
Partner With Porter Capital for M&A Financing Solutions
Porter Capital is an expert at providing effective capital solutions. As an alternative lender, we can provide the financial assistance needed to help you maximize the deal value by improving cash flow, lowering risks, reducing debt and enhancing bargaining power. Contact us today to get started.