How Asset Based Lending can be used to fund acquisitions and what you need to consider
Despite the dreaded "B-word" and sluggish domestic growth, UK mergers and acquisitions (M&A) activity has remained steady throughout much of the last three years. Many also believe a post-Brexit uptick is likely given the clarity the recent General Election has brought.
The latest research conducted by Corporate Finance firm Corbett Keeling supports this, suggesting ‘a further pick-up in deal making activity’ in 2020 with deal volumes below £100m predicted to increase over the next six months by 71% of respondents, with the remainder expecting no change. For the larger deals over £100m, 43% of respondents have forecasted an increase, which is a huge rise on the previously forecasted 17%. A further 43% expect no change, leaving only 14% predicting a decline on deal numbers.
In the SME market – which by our definition are businesses which turnover sub £100m – Brexit has perhaps been less of an acute issue in terms of holding up deals. Sourcing finance to complete a deal can often be the bigger challenge. Committed lines of credit, availability of bonds/similar debt instruments and bank term loans are far less accessible. In recent years, Asset Based Lending (ABL) is one of the funding sources that Management, Trade, Private Equity (PE) and serial entrepreneurs are using to facilitate transactions.
We look at four scenarios where ABL may be used to fund an acquisition:
- Succession Issues / Management Buy-Out (MBO): We often see successful, familyowned businesses with no obvious next generation to take over. These businesses are often prudently run with low levels of debt on the balance sheet, with a well-established and loyal customer base. Capable, second tier management often lack the finance themselves to fund an MBO. Using ABL, funding can be raised against the unencumbered assets to make the deal happen. Most ABL funders will look favourably on this type of transaction given there is strong continuity via the existing management team who will help maintain key relationships and keep the business running smoothly post-acquisition.
- Private Equity (PE) acquisition: In recent years PE investors have demonstrated that, with the right partner, ABL funding can be used as part of a day one deal structure as well as ongoing working capital. This helps boost returns on equity for the House and ensures the transaction is more self-funding than it would be on internal equity/debt basis, a fact that is likely to carry favour with any investment committee. Invariably, lenders tend to be more relaxed around agreement covenants, conditions and funding levels when working alongside a reputable PE house.
- Management Buy-In (MBI): Incoming new management acquiring a business is often considered a more risky type of transaction. The principal risk being that the business may lack continuity to manage its key stakeholders once the vendors have exited. This, however, can be an over simplification and each deal should be considered on its own merits. Again, ABL can be used effectively to generate the funding needed to undertake the buyout, however the lender is likely to undertake more due diligence on the track record of incoming management and positive sector experience will be viewed favourably.
- Venture Capital / Build and buy strategies: The serial entrepreneur/speculative investor has long been an advocate of using ABL to build a portfolio of businesses for one simple reason – speed. Typically, the acquirer spies an undervalued business which could be bolted on to their existing portfolio of businesses. In these cases the lender may be asked to refinance existing debt and provide a small amount of extra "cash out" to the exiting owners as part of a deal structure. Once the acquirer has developed a track record with a lender, deals can be concluded swiftly and with more flexible facility arrangements.
So, what will an ABL funder want to know before funding an acquisition? Here are five key points to consider:
- Management: Post deal who is actually going to be running the business? If it is the incumbent management team what is their track record to date? If it is a new management team, do they have relevant sector experience?
- Outgoing Management: Does the outgoing management have suitable non-compete arrangements to mitigate the threat of them setting up and taking the customer base with them?
- Cash is (still) king: The more aggressive the funding structure (i.e. the more ABL cash is flowing out to the vendors) the more scrutiny will be put on the cash flow forecasts and short term viability. Ideally the lender will want to see that the business has sufficient headroom in its facilities and can withstand any unforeseen bumps in the road. There is no point buying a business only for it to run out of cash at the first sign of trouble.
- Use Advisors: Many ABL funders may take comfort from the acquirer working alongside a reputable advisor. This typically means that a lender has the answers to the questions before they have even thought to ask them – this can be particularly useful when validating the future viability of the business post acquisition. Credible, third party forecasts are often invaluable.
- What’s ‘the story’?: Unlike a loan or an overdraft an ABL facility is one which is far more relationship-based. The funder will be interested to know why the target is attractive, deal rationale, any synergies with other portfolio companies, the acquirers future exit strategy and overarching sector-risks. The hard facts and figures are important but the deal story shouldn’t be overlooked – this is always key to us at BFS.
Ultimately, there are a variety of situations where ABL can make deals happen, each scenario is different and at BFS we always welcome the opportunity to work with an acquirer and advisors to explore the possibilities. We look forward to working with you to make 2020 a successful year for deal makers.
Read our case study about Invoice Finance funding a management buyout.