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Financing a Business Acquisition

Ready to stake your claim in another business? Here's the best way to finance the deal.
February 24, 2003
URL: http://www.entrepreneur.com/article/59858

Readers want to know about the "best" way to put together a funding deal when purchasing another business. The question actually spans two categories: The first addresses an entrepreneur who wants to buy an existing company and manage it rather than launch a start-up company. The second area deals with smaller, entrepreneurial ventures that want to expand by purchasing another company.

This second category has two separate types. The first expansion deal is where the entrepreneur buys a competitor and focuses on garnering additional market share by purchasing new customers and a new market presence to complement the acquiring company's marketing and sales strategy. The second expansion type is where the entrepreneur buys a new piece of the value chain. This includes things like a wholesale distributor purchasing a retail outlet (integrating downstream on the vertical marketing value chain) or when the wholesaler purchases the manufacturing operation that is upstream.

When the question is posed about financing any of these acquisitions, there are four basic rules to adhere to when structuring the terms of the deal. First, the best financing deal starts with the best disclosure. Get a straightforward accounting of what it is you're buying. Have a clearly delineated list of assets and outstanding liabilities on these and know how much these assets carry in terms of tangible market value, post-acquisition. Leave nothing to chance. Be absolutely sure of what it is you're buying, from equipment, machines, vehicles and buildings to receivables and inventory, patents and other intellectual property.

The second rule covers the existing financing in place with the target company. A firm that has a large owners' equity position and little debt could be a good candidate for acquisition with long-term debt financing. The assets come over unencumbered by outstanding liabilities, so the new debt on these and the accompanying interest payments on this new loan could be a very good fit with the overall financial picture of the post-deal enterprise. A firm that already has a good deal of debt is going to bring the weight of interest payments and tied-up assets to the post-deal planning for the going concern.

The third rule deals with the positions of the existing shareholders in the target company being acquired. On the one hand, these investors could be very happy swapping their current stock for shares in the acquirer's firm, because the long-term prospects for growth look strong in the post-deal combined company, and they're happy to share in that growth. On the other hand, the original investors in the target firm may be very anxious for a liquidity exit, especially if they have been holding their shares for a long time.

Taking inventory of existing shareholders' expectations is crucial to ensuring strong backing for company policies post-acquisition. For example, if the existing shareholders are happy to swap their shares for new shares in the acquiring firm, then the entrepreneur needs to be aware of the relative percentage ownership stakes in the post-deal structure. The previous shareholders could become one of the biggest headaches to the direction and policy implementation as the business tries to move forward.

Another situation could occur where the original shareholders really want to walk away from continued ownership. In this case, the entrepreneur will need to factor in some form of liquidity to the deal, to provide the existing shareholders with a cash-out scenario. The extra cost of buying them out entirely may appear at first to be an unnecessary increase in the purchase price. But consider that this buyout could also bring you a company free and clear from these previous shareholders, as well as all their opinions and personal concerns about the company. Having their votes no longer in the mix could prove to be one of the best uses of funds in the acquisition deal structure, because it's an easy way to close out their positions (which includes all their comments, questions and opinions on everything pertaining to running the company).

The fourth and final rule involves having the firm professionally valued by an independent valuator. You'll have your own value, and the other person will have their own value expectations. A third party brings an objective opinion, and the buyer and seller can split the cost of the valuation so that neither party exercises any undue influence on the valuator's final figure.

The "better" way is the only way to do an acquisition. Anything else would be unacceptable in getting the best deal possible.

David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 emerging, fast-growth entrepreneurial ventures since 1984.


The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.