Unless a buyer has sufficient cash reserves, a key question for buyers faced with the opportunity to acquire a business is how to fund the acquisition.
The answer to this will depend on a number of factors, from the creditworthiness of the buyer to the nature of the business being bought.
However, the main options open to a buyer are as follows:
Whilst bank funding can be difficult to obtain for some potential buyers, banks will, in the right circumstances, lend to good, solid businesses.
The availability of bank funding will largely depend on the level of security a business is able to provide and so the banks will be more attracted to those target businesses with a strong asset base and a solid trading performance.
The assets and trading performance of the buyer may be added to the target business in order to ascertain whether bank funding is feasible, particularly in low geared (ie not having a high level of borrowing in proportion to capital) businesses with a solid and reliable turnover / track record of performance.
Asset Backed Lending
Asset Backed Lending (or ABL as it is often referred to), such as invoice discounting, is becoming a more common method of funding an acquisition.
ABL is an effective way for funders to minimise their exposure by taking security over particular assets, for example book debts or machinery. It also allows for the business to expand by providing more credit as turnover rises.
Private Equity / Venture Capital
Private equity and venture capital providers can be an excellent source of capital for funding acquisitions.
However, the target business does need to have the right characteristics for the venture capitalists to be interested. There will also often need to be a clear opportunity for the target business to grow or a consistent delivery of "EBITDA" (earnings before interest, tax, depreciation and amortisation) / profits with strong projections, in order for these investors to maximise their return on investment.
In contrast to bank funding, VCs will often be looking for a more involved role in the acquired business and look to add value to the business in the form of expertise and contacts.
The VCs will invariably want a representative to sit on the board of directors of the target company or the buyer and will often require certain veto rights. However, these veto rights are designed to protect their investment, rather than to act as a mechanism for controlling the target business.
The best VC arrangements are seen as a partnership whereby the VC adds value as well as the requirement investment.
High Net Worth Individuals / Business Angels
Due to low interest rates, stock market uncertainty and an unpredictable property market, individual investors are an increasingly viable source of funding for acquisitions, particularly if it can be structured in a tax efficient manner - see our SEIS and EIS Investment Guides.
High Net Worth individuals, or Business Angels as they are more commonly known, are usually seeking investment opportunities in business sectors they know well, as often seen on the likes of Dragon's Den. This affords them the ability to offer more than just finance and can be a useful resource for industry expertise and business contacts.
In a similar vein, a management buy-in ("MBI") can be a good a way to fill in any gaps in the management team, with the new member of the management team contributing the capital required in order to make the acquisition viable.
Increasingly, sellers of a business are willing to accept some form of deferred consideration, in effect self-financing the acquisition.
This means that the sellers receive a proportion of the purchase price in cash at completion and further payments are deferred.
This is particularly useful where the sellers are looking to maximise the value of the business as the deferred consideration can be linked to certain KPIs (key performance indicators) in the form of an earn-out arrangement.