Funding strategic acquisitions through private capital markets

Editor’s note: In this three-part series, we will focus on private capital markets as a funding option for growth and fueling long-term strategic planning. Then, we explore what private capital markets are and, later, how to build this kind of recapitalization into your strategic planning.

Let’s say you own and/or run a middle market company with EBITDA of $4 mil to $25mil. Your business is well run, has a strong management team, and you see opportunities to enhance its competitiveness and value by executing strategic acquisitions.

Further, your company is “asset light,” meaning that you don’t require heavy investment in tangible assets to generate strong cash flow and profitability.

Examples of asset light businesses would include — but not limited to — healthcare, technology and business services; warehousing, logistics and distribution; light manufacturing; and technology sectors. These business models can have strong cash flow and quality of earnings, but little in the way of tangible assets to provide as collateral for debt funding.

A commercial bank — even one where you have a strong relationship — will be limited to providing funds based on the liquidation value of your tangible assets.

This funding constraint may lead you to believe that your acquisition options are significantly limited in both size and quality.

This perception may in turn lead to you “kick the tires” on small targets with limited resources, unstable quality of earnings and a mediocre talent base. In short, funding limited to tangible collateral may force you to take baby steps where you should and want to be making bigger moves.

More from this series

Part 1: Funding through private capital markets can help you reach your strategic goals

Part 2: Private capital markets: A primer on raising funds without losing equity

Non-bank lending can help you reconsider your strategic targets

As discussed previously in this series, this perceived limitation may prove false, as non-bank institutional cash-flow lenders may be able to provide senior funding of 2.5x-5x the combined EBITDA of your company and the acquisition target.

This additional funding could meaningfully broaden the scope and scale of your strategic targets to include larger, more stable companies with a proportionately deeper talent pool.

By example, let’s assume you run a company with $7 mil in EBITDA and available collateral to support an $8 million asset-based loan. You’re considering the acquisition of a strong, well-run target with $3 million in EBITDA and tangible assets to increase that lending facility to $10 million.

Unfortunately, as fair value for a company of that size and quality would likely be in the range of 6x-7x EBITDA ($18 million to $21 million), $10 million is simply not sufficient to close a deal.

Discouraged by the funding limits and intimidated by the price tag, you may revert to less substantial and probably weaker targets that fit your “budget,” but may not move the needle on your business performance.

Alternatively, non-bank institutional lenders may be able to fund the $10 EBITDA combined entity with $30 million to $40 million. This would position you to make a fair offer for a strong company that will enhance the competitiveness of your enterprise.

Even further, that level of funding could provide a working capital line of credit and “dry powder” to fund organic growth or yet another acquisition.

Higher levels of funding could mean higher valuations

As compared to a “baby step,” a transaction of this magnitude is far more likely to allow shareholders and management teams to drive additional value through administrative and operational savings, commercial synergies, scale of purchasing and other paths.

The resulting increase in your talent pool may also allow the creation and/or acceleration of other growth initiatives.

On the subject of valuation, as your company scales, it is likely that value as a multiple of profits or revenue will increase, optimizing value for all stakeholders.

By example, your $7 million EBITDA company may be valued on a stand-alone basis at 7x-8x EBITDA, but adding an acquisition that boosts the combined EBITDA to $10 mil with further upside through merger synergies, may be valued at 8x-10x EBITDA.

In short, full awareness of available funding can potentially unlock market opportunities you thought were unattainable, allowing your enterprise to scale and create greater shareholder value far more quickly and effectively than if you were to rely solely on traditional asset-based lending.

Whether pursuing an organic or external growth strategy, this awareness is a prerequisite to developing and executing a strategic plan to maximize the value of your business.

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Related Resources 

Should you really sell your company? 

Predictive analysis for your business: Cash-flow forecasting

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