Funding a key acquisition is a challenge faced by many new businesses. Companies in early growth stages often ask us how they can make the most of strategic acquisition opportunities, at a time when they are not awash with cash.
Here are some of the routes we frequently suggest, along with their advantages and drawbacks.
Non-cash consideration
Provided you can reach an agreement on valuation and other matters, an acquisition can be made in return for equity in your company. This has the advantage is that little or no cash is involved, depending on how much equity you are prepared to release.
The drawback is that with two companies to value, negotiations can be tricky. Plus, releasing equity will have a dilutive effect on your company's shares and stock price.
Buy now pay later
It might be possible to defer payment for your acquisition. This could be simply time-based (e.g. an instalment payment plan) or with payments dependent on contractual triggers, such as your target's performance.
As with any acquisition, you could incorporate an earn-out mechanism or other performance metrics, so the price you pay is governed by your target business's post-acquisition performance. You'll be able to see how well your target works, while the vendors have an incentive to ensure it meets or exceed its potential.
The upside is that you don't have to give away equity or find cash (unless upfront part-cash payment is part of the deal). The downside is that this arrangement can be a tough sell to vendors, and earn-out negotiations can be challenging to get right commercially.
Borrow to buy
Assuming you have sufficient financial standing, you can borrow money to fund acquisitions – as long as the lender buys into your acquisition proposition. Again, it has the advantage of not costing you cash or equity. The disadvantage is that your lender will become a material creditor, and will impose conditions and security for the debt before agreeing the finance. The less collateral you have to offer, the more onerous the terms are likely to be.
Issue shares to buy
You could raise finance through a fresh issue of shares, either to existing or incoming investors. You don't have to find cash, but it will have a dilutive effect and may involve handing over further control or protective rights to your new investors. It will also involve the complexity of two ongoing negotiations, with your target and the investors.
Gain a toehold and buy later
If you can't afford to buy your target business outright, you could potentially acquire an option in it and/or first refusal if it comes up for sale. Similarly, you could take a minority equity stake in the business.
This is an appealing, cheap option when cash is tight. It lets you see how the target business is performing and potentially means you could benefit from a degree of equity upside (increasing the value of your share) which could be good where you and the target have a planned or existing commercial trading relationship between. However, options in private companies are hard to value and may never be taken up. Agreeing on the option's mechanism to determine the future valuation of the target can also be challenging.
Get the rights to the best bits
As an alternative to acquisition and if you're more interested in having access to the target's intellectual property, you could potentially negotiate an appropriate licence and/or cherry pick other strategically desirable business assets. This is a cheaper option than outright acquisition, but doesn't leave scope to benefit from future equity increases.
Hire the people instead
The greatest value of many companies is in the people who work there. You should ask yourself whether it would be quicker and cheaper to simply hire the key individuals.
Although this is potentially cost effective, top talent can be hard to prise away; they may well be bound in by equity incentives. And the target's real value may actually be in its IP.
Build it yourself
Unless there's something especially defensible and proprietary in the target's intellectual property, it's worth undertaking a feasibility study and costing what it would take to build a similar, possibly competing solution.
By not having to deal with third party sellers, you would have more control over the project, making it potentially more cost-effective and attractive. Conversely, you'd need to factor in the time and cost required, and whether you have access to the resources you need. Then there's the additional concern of navigating intellectual property rights to ensure your investment is protected and delivers the envisaged return.
Survey the market
You may already be focused on a particular target. Yet it's worth doing some market research, potentially with the help of corporate finance intermediaries, to identify other targets which could bring similar value and benefits, but potentially represent better value for money.
You'll be better informed, but beware: such research can be time-consuming process and distract you from your core business.
Just wait
There are some depressing figures for start-up success rates, so it's worth examining your company target's funding runway. There are potential bargains to be had if their funding runs dry and they move towards an urgent or distressed sale.
On the other hand, you could be waiting for a long time for such a bargain, with no guarantee of a transaction and the risk that other bidders might move in. If you purchase from administrators, don't expect the deal to offer much comfort in warranty or indemnity terms.
Our advice can help you avoid risks and grasp opportunities, so whether you're a start-up, fast growing company or established player, do get in touch.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
