In many cases purchasers in an M&A deal will obtain debt financing to cover a portion of the purchase price. Fortunately, in Canada the options for acquisition financing are plentiful. Common 'types' include:
Senior Debt: the Bank Loan
Banks and other senior lenders can design a range of tailored solutions to purchasers' funding needs. Broadly speaking, these loans can be classified as follows:
- Fixed Term Loan or Revolver: The fixed term loan is credit for a fixed amount to be funded, and paid back, according to a pre-determined schedule. A revolving loan allows a borrower to drawdown, pay back and re-borrow a capped amount of credit at its own discretion. Loan agreements can feature some combination of the two depending on the purchaser's up-front financing needs and future working capital requirements.
- Single Lender or Syndicated: Syndicated loans refer to credit granted by a syndicate, or group, of lenders. This form allows lenders to participate in larger financings without requiring high capital outlay or risk exposure. A syndicated loan is often led by one lender acting as agent, a role which typically includes negotiating and administering the loan. Syndicated loans can add complexity to a deal due to issues, including ranking, that must be negotiated between lenders.
- Unsecured vs. Secured: These categories are distinguished based on whether security is taken over the assets of the purchaser (or target) to secure payment of the loan. In large acquisition financings the lender(s) will always demand security, which can be taken over virtually any tangible or intangible assets. It is common for lenders to also require that the purchaser or its affiliates provide guarantees, which can be secured or unsecured.
Asset-based Loans (ABL)
ABL is a niche form of lending that will be attractive to borrowers in certain circumstances. The amount of credit available under the loan is tied to the value of specific assets of the borrower. Typically, ABL lenders prefer liquid assets such as accounts receivable and inventory, and will advance funds based on a percentage of the assets' value. ABL can be attractive where the borrower is rapidly growing or highly leveraged, and needs fast, flexible funding. Borrowers should know that proof of steady, high-quality receivables and strong financial reporting capabilities are pre-requisites to obtaining ABL financing.
Leveraged Buy-Out (LBO)
An LBO is an acquisition finance structure in which debt is used as the main source of funding for the purchase price. This structure allows a purchaser to make large acquisitions while contributing relatively little of its own capital. Security is taken in the assets of the purchaser and the assets of the target being acquired. Lenders, cognizant of the risks associated with high leverage, will often insist upon strict operating and notice covenants. For this reason, purchasers typically only engage in LBOs of mature companies with stable, predictable cash flows. While high-profile LBO failures have illustrated the risk inherent in this approach, if used successfully purchasers can realize a higher return on equity than they would if 'ordinary' levels of debt were used.
Owner (or Vendor take-back) Financing
In this acquisition finance structure, a portion of the purchase price is paid on closing and the seller agrees to defer and finance the balance of the purchase price. Post-closing, the purchaser owns the business while making principal and interest payments to the former owner. The appeal of this structure is context-dependant. Sellers are most likely to offer financing at a lower cost to sweeten (and expedite) the deal. Both parties will appreciate the reduced cost that comes with avoiding third party financing, but sellers should have a clear understanding of the credit-worthiness of the purchaser and the risks of lending.
Mezzanine financing is a hybrid form of debt that gives the lender the right – in certain circumstances – to convert its loan into an equity interest in the borrower. This form of debt is typically unsecured and subordinate to senior debt, and as such usually carries a higher interest rate. Lenders often prefer mezzanine financing over an equity injection as interest payments on debt are tax deductible. The caveat is that, should the mezzanine debt be converted into equity, the purchaser's shareholders will experience ownership dilution. Overall, the convenient nature of mezzanine financing makes it well-suited as a secondary source of funding for acquisitions.
Many financing solutions are available to cater to the complex needs of the parties to a Canadian acquisition. Purchasers should be aware – in advance of seeking acquisition financing – that these arrangements can add complexity and time to a transaction. Further, in the Canadian private M&A context 'financing out' clauses are not common, and as such financing should be established early so that the purchaser is not forced to proceed without it. Those seeking advice about their acquisition finance options should contact a member of NRFC's M&A or Corporate Finance teams.
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