No two M&A deals are the same, but they all require one common element: funding. Where that comes from and how it is structured can impact a deal in a multitude of ways.
A good deal can be helped or harmed depending on how it is funded. Financing options may well be plentiful in some cases but choosing the right approach requires discipline. There are trade-offs to be made no matter the option, be it cash, debt, equity or vendor finance. Each carries with it challenges to be managed.
That’s why it’s best to start by focusing on the risk involved so that the funding mix used offers control as well as a blend of flexibility and resilience.
“In my experience, the right balance starts with the growth plan and your tolerance for risk,” says James McMenamin, corporate finance partner at PwC Ireland. “Using your own cash can make execution simpler and keeps control firmly in your hands, but it concentrates risk and can leave you short when it comes to integration spend or the next opportunity.”
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When it comes to debt-based financing, taking on as much as possible is no longer the core goal. Instead, the focus is on a form of financing that is structured in a sustainable manner. Leaving yourself some headroom has become more en vogue in recent times, irrespective of lender limits.
“Private credit has been attractive because it provides certainty of funds and speed, which helps in competitive processes and lets you keep dry powder for post-close initiatives,” says McMenamin.
“In today’s environment of stabilised interest rates and tighter valuation discipline, I advise calibrating the mix to the durability of earnings and keeping sensible headroom for shocks.”
This naturally leads to the question of how to identify a sustainable level of borrowing? Lender appetite doesn’t directly equate to safe leverage. Rather, those borrowing should think about what is most manageable for them.
“A sustainable level of borrowing is one that the business can comfortably service across a full cycle, with room to absorb shocks, rather than simply the maximum amount lenders are willing to provide,” says McMenamin.
“Above all, the capital structure should allow management to deliver the value creation plan without being boxed in.”
There are scenarios where borrowing isn’t the right tool, not due to a lack of availability but as a matter of fit.
That’s where bringing in an equity partner can prove attractive, particularly as they can help with both speed and scale.
“I lean towards an equity partner when the plan involves accelerated buy and build, cross-border expansion or a transformation that benefits from hands-on support and patient capital,” says Freddie Saunders, corporate finance director at PwC Ireland.
“The trade-offs are mainly around governance and alignment.”
For some, those trade-offs may be a bridge too far. This is where another option such as vendor finance comes into play. This is very much a situational option, one that can simplify a lot of the process for those involved.
“Vendor finance works best as a targeted tool to bridge valuation or timing gaps in midmarket or owner-managed deals,” says Saunders.
“I like simple, time-bound structures, whether that is a short-dated seller note, deferred consideration or a well-defined earn out.”
With the variety of options available, it’s always worth taking a step back to get a better view of the broader funding environment to find your best fit.
“There is significant financing available for acquisitions, particularly with the influx of private credit providers keen to gain exposure to Irish deals,” says Tanya Sexton, corporate finance partner at Deloitte.
“Careful consideration of the underlying cash generation of the business and stress testing its resilience to shocks is important when assessing appropriate leverage levels.”
So far, all of these choices have assumed that a business is in position to access debt on acceptable terms. This won’t always be the case. Be it cash-flow pressure, rising interest costs or some unexpected shock, options can narrow quickly. At that stage the goal is making sure the deal can proceed.
“When cash flow can’t sustain additional debt or there has been a credit-deteriorating event that closes the debt markets to the business, an equity solution needs to be carefully considered only after all debt avenues have been exhausted,” says Sexton.
In the end, the decision you make on funding will be felt long after a deal has been completed. Of course, what that impact looks like depends on the choices you make ahead of time.
Whatever structure you choose will impact the flexibility and resiliency of the business going forward. There is no one-size-fits-all answer, but it is important to do the work required to find the best mix that works for you.
For all the advantages and trade-offs, a good funding choice comes back to the core principle of discipline. If the funding structure reflects the decision-making process that led to it, then it will work to aid management going forward. With a smart strategy, the right funding mix can prove to be an enabler for both the deal and business going forward.
