Eyeing the next stage of growth for your company? You might be considering an acquisition. And while the company you’re looking to acquire and the terms of the deal are important, you’ll also need to come up with an acquisition financing plan.
Acquisitions are a powerful strategy for business growth, and using debt to secure the required capital is becoming increasingly popular. In the first three quarters of 2023, 86% of leveraged buyouts (LBOs) were financed through private credit, a significant increase from 40% in 2018. This upward trend highlights the growing reliance on debt for acquisition financing.
Let’s take a look at what an acquisition is and explore the top benefits and use cases for this loan type. By understanding when and why to use debt for acquisition financing, you'll be better equipped to make informed decisions when preparing for your company's next acquisition.
What is an acquisition?
Acquisition financing refers to the funds a company secures specifically to purchase another company. This strategic move allows a smaller company to expand its operations and enhance market presence, efficiency, and capabilities.
Companies may pursue acquisitions for several reasons, including:
Expanding Market Presence: Acquiring a company in a different region or market can help increase reach and customer base.
Diversifying Products or Services: Adding new products or services through acquisition can enhance a company's offerings, integrate new verticals, and attract more customers.
Gaining Competitive Advantage: Acquiring a competitor can reduce competition and strengthen the company’s market position.
Accessing New Technologies: Acquiring a company with advanced technology or expertise can accelerate innovation and development.
Achieving Economies of Scale: Merging operations can lead to cost savings and increased efficiency.
Ideal conditions for an acquisition include a strong financial position, clear strategic goals, and the potential for significant collaboration between the acquiring and acquired companies.
What is acquisition financing?
Most companies don’t have the cash in the bank to buy another company outright. Due to the resulting capital disparity, companies turn to other methods to secure the funds they need. Typically, companies get acquisition financing by offering stock, raising equity capital, or using debt. Common sources of debt include bank loans, lines of credit, and loans from private lenders.
Borrowing capital to finance a business acquisition is often a cheaper option in the long run than equity financing. A major benefit of debt is that it doesn't require issuing shares, which means there is no dilution of equity and your company maintains a greater level of influence and ownership.
Acquisition loans are prevalent among businesses of all sizes, from small enterprises to large corporations. By using debt to finance an acquisition, companies can leverage the acquired assets and projected cash flow to repay the loan. This method enables significant growth and competitive positioning without sacrificing equity.
Why use acquisition loans?
Using debt to finance a business acquisition is often the most cost-effective option for companies. Unlike equity financing, which involves issuing shares and diluting value for existing shareholders, debt financing keeps ownership intact. Because payments are fixed, consisting of principal and interest, the overall cost to the company cannot increase based on the company's future success.
Here are some other key benefits of acquisition loans:
Immediate Funding: Businesses can quickly access the funds they need to complete an acquisition.
Increased Profit Margins: Even with loan repayments on your books, acquisitions can lead to higher revenue and profit margins by expanding operations and market reach.
Competitive Advantage: Companies can gain more market share and access new resources to boost their competitive edge.
Access to Expertise: Acquiring another company often includes bringing in experienced professionals, enriching the talent pool and fostering innovation.
When planning your acquisition financing, take the time to evaluate whether a loan could be the right strategic option for your growing company. Are you looking to strengthen your market position while preserving equity? Here’s how to tell if acquisition financing is a good fit for your business.
When should you use debt for acquisition financing?
Debt financing for acquisition is preferable in several scenarios. As we’ve seen, it's considered more cost-effective than equity, making it ideal for companies that prefer to maintain control and avoid diluting ownership.
Businesses seeking faster access to funding also often opt for debt over equity, especially when acquiring smaller amounts. Debt financing can offer tax advantages, making it especially suitable for companies aiming to manage long-term budget concerns efficiently.
Once you’ve decided on securing a loan for acquisition financing purposes, it’s a good idea to prepare for a thorough financial analysis to make the process easier to navigate. Lenders will likely evaluate projected cash flows and financial health for both the acquiring and target companies before approving your debt financing.
Final Thoughts
Leveraging debt for acquisition financing offers companies a strategic advantage by empowering them to expand operations and enhance market presence without diluting equity. Debt financing, increasingly popular for its cost-effectiveness and immediate access to funds, supports various growth strategies from market expansion to technology acquisition.
By understanding when and why to opt for debt over equity, businesses can navigate acquisitions more effectively, securing their financial future while maintaining control and maximizing competitive edge.