An Overview of Acquisition Financing – Part 3
In previous posts, we looked at corporate capital structure, the three main kinds of senior bank loan and the main components of loan documentation. This overview concludes with bridge loans, other kinds of acquisition financing and an overview of major tasks in the financing process.
Concern for financial resources takes its place early in the strategy process. If the buyer will need financing, its options will be greatly increased if those discussions are underway before acquisition discussions take place. Otherwise, a buyer may need to take out a “bridge loan,” which is often quite expensive, or include a financing condition in its purchase offer, which makes the offer much less attractive. Bridge loans are relatively short term, expensive loans that bridge the gap between closing anytime a permanent financing can be put into place. As with permanent financing, bridge loans are generally secured by all the assets of the company. They keep the borrower on a very tight leash. Bridge lenders do seek to foreclose or force out management if their loans are not repaid promptly.
Other Kinds Of Acquisition Financing
While the details of other kinds of acquisition financing may vary, many of the core elements of interest to a buyer managing the deal process overlap with those of dealing with a senior lender. For instance, subordinated loans from private lenders are similar to senior loans except as to collateral. Some differences with different kinds of financing include:
- Subordinated debt may require negotiation with the senior lender as to the terms of its subordination.
- Preferred stock, common stock and warrants generally require additional negotiation among stockholders that culminates in a stockholders agreement.
- Non-bank financings may require the company to prepare disclosure documents or filings under federal or state securities laws. This can be an expensive and time-consuming process.
- Seller financing is generally just a promissory note to fill in the gap between purchase price and what a bank or other lender is willing to provide. However, they require the same kind of intercreditor negotiations as subordinated debt.
- The broader the distribution of securities, the more likely it is that a buyer will need the help of an investment banker to place them.
Major Acquisition Financing Tasks
At the time the initial strategy is being developed, company resources are a major factor to consider. The CFO and treasury functions will play an integral role in these determinations.
If new financing is needed, it is best to begin establishing relationships with lenders and investors well before the date the company will need to pull the trigger. On the other hand, existing lenders want to be involved early, too, if only to keep an eye on covenant and borrowing base compliance, and management generally wants to keep an investor with a voice on the board happy.
As lenders and investors become interested in the company, they will want to do due diligence on both the company and the target. Initially, this will take the form of limited financial diligence on the company and a company overview. However, if their interest progresses, it will turn into something more elaborate. The borrower will need to assemble a data room with a subset of the information it would need if it were going to be the target. The parties will agree on the general terms early on, which are generally incorporated into a term sheet.
The borrower’s financial modeling must include the transaction fees associated with acquisition financing. In addition to origination and facility fees, lenders and investors generally require the borrower to pay the cost of their legal fees as well as its own. These can be significant.
The documentation and closing stages are a blizzard of paper. While small companies may take out loans on pre-printed bank forms, as the size and complexity of facilities increase, the documents can turn into thousands of pages and hundreds of thousands of dollars worth of detailed, customized implementation. Since the company is paying its lenders’ legal fees, cooperation in all logistical respects is in the company’s interest.
In post-closing documentation, lender’s counsel often has a long checklist, including recording all security documents and providing copies of deal documents to all members of the syndicate. The lender itself has internal systems to manage. However, these generally do not require detailed input from the borrower except to comply with administrative requests. In other words, they may turn into individual tasks that are reactive to what has to be done, but are generally not an affirmative set of tasks that the borrower has to plan around.
In the integration stage, acquisition financing becomes a treasury and legal issue. Does the buyer have enough funds to do the integration it wants to do? Will the integration affect cash flows? Do any of the integration tasks require consent under the financing documents? These tasks require coordination between the integration team and corporate control functions.
In the post-closing adjustment process, some of the major questions include whether there are financial resources available to pay the post closing adjustment amount, whether payment is consistent with the terms of the financing documents and whether the lenders are prepared for any litigation that may come out of any failure to pay the full amount of the adjustments.
Financing tasks do not fit neatly into a chronological sequence of events that leads inexorably to closing. While the details of the financing may be put into place between signing and closing, it is a separate process that happens in parallel with the acquisition process. In today’s increasingly compartmentalized business world, different teams may work on the acquisition and financing tracks. However, the teams need to communicate with each other, to share information and to coordinate their activities. They need to understand overlapping due dates, the need for cross-referencing data and task dependencies. There needs to be some integration of tasks, too, such as making sure that letters of credit supporting break-up fees are available at the appropriate time (LOI or purchase agreement).