An important part of the Exit Plan is understanding what where the funds come from and in what form. We have put together a few main points to help inform the exiting owner. So, let’s take a look at the types of capital available and what type of buyer would attract, have and / or deploy that capital to buy your business in the future.
Ebb and Flow of Markets
First lets understand that markets fluctuate and investors will put money on the street during economic prosperity and may retreat from the market during downturns. The most recent recession was a classic example of financing sources retreating from markets, reducing credit, calling in outstanding loans and withdrawing from buyouts all together. Fortunately, not all capital behaves in this manner.
Strategic Buyers with ‘Cash on the Sidelines’
Our first source of capital to examine is the cash that is ‘sitting on the sidelines’ of corporations around the world. Now, theoretically, this cash should either be put to work either in internal / ‘greenfield projects’ or it should be returned to shareholders in the form of a dividend (or, alternatively, through the repurchase of outstanding shares). If you can get a strategic buyer to pay you cash for your business, then you don’t need to ask too many more questions and can start a targeted negotiation towards a best possible price.
Senior Bank Debt
You may find that a future buyer of your business wants to fund the acquisition by borrowing from a bank. Banks are open to this type of business and many will finance the acquisitions for certain buyers who do not have the cash (or perhaps some who do have the cash but, for corporate finance and other reasons they prefer to borrow to purchase your business). Banks are the classic example of capital that flows in when markets are good and flows out when markets are bad.
It is helpful to know that your buyer knows that senior bank debt is limited. Banks will not loan 100% of the value of a business to a buyer and not all buyers will qualify for this type of financing. Senior debt is a low margin business with no upside potential and which is heavily regulated. These factors combined will limit your buyers’ overall access to this type of debt (particularly depending upon market conditions) and will impact what a buyer can pay for your company.
Private Equity
Moving past debt, we now examine the world of private equity. This ‘equity’ capital is far different than debt capital primarily because it does not need to be re-paid. In this regard, equity comes into the company, making for a stronger balance sheet than heavy amounts of debt. Now, don’t be fooled by private equity entirely because the truth is that while PEGs have capital available to make acquisitions, they generally prefer to also borrow senior debt, in addition to the equity that they contribute to the deal, to finance the acquisition.
Private equity, however, is long-term capital. PEGs know that they may not get their money / equity out of the business for many years (perhaps 5 to 7 years). Further, this is risk capital in that if the company fails, it is generally the debt holders who are repaid first (i.e. have a first lien on the assets of your business). The private equity business model is highly incentivized with a lot more upside than senior debt capital. The additional risk of and higher returns of private equity markets make it more robust to market ebb and flows.
Mezzanine Financing
Mezzanine debt is a mix of debt and private equity financing. In fact, the capital is structured in the form of a high-interest, subordinated [to the senior debt] loan. The mezzanine capital also will, in most cases, have an equity component called a ‘warrant’ which provides some upside potential to the ‘mezz debts’ overall return. Mezzanine debt works mostly with private equity and senior debt as ‘bridge capital’. Mezzanine debt will invest in riskier projects than senior debt (because they have a higher return potential) and will ‘bridge’ the financing structure where a buyer does not want to fill it with equity.
Concluding Thoughts
As an owner who is thinking about an exit, it is in your best interest to treat your future buyer’s financing sources and availability the same as if they were your own issues and problems to solve. By understanding the sources of capital that your buyer may have access to, you may be in a position, prior to your exit, to impact the way in which your buyer can access different levels of capital. We at Opus Consulting Group take uncertainty out of the deal and help you in understanding and thinking like a potential buyer.
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