1. What financing options are currently most prominent in the Irish M&A market?
Finance for funding M&A usually comes from a combination of debt and equity sources. The type of finance is dependent on where you are in the life cycle of the development of the business and the capital structure at the time you go to raise finance. The good news is there are more funding options available than any time in the recent past ranging from traditional bank funding, alternative debt providers and private equity players.
Availability of capital is no longer an impediment assuming you have a business plan that is credible, have growth potential and you have capable management who can deliver the plan. There are a number of factors that need to be considered when assessing the optimal funding structure and the sources of finance for prospective M&A (i) sustainable level of cashflows in the combined businesses (ii) upfront costs associated with the integration of the target and timing of potential cost-savings (iii) working capital and capex requirements (iv) level of security available for funders (v) target return on equity.
2. How are interest rates and tighter credit conditions affecting deal structures?
Albeit we have seen a slight reduction in the past year or so, borrowing costs remain elevated for financing transactions compared to previous years resulting in a shift in the financing mix on deals. Dealmakers are adapting by reducing leverage, increasing equity contributions, and using deferred/contingent payments to bridge valuation gaps.
For those private equity-backed deals, increasingly the approach adopted is for them to finance the deal themselves upfront in full and thereafter, once the deal is concluded, seek to replace a portion of their funding with debt at a sustainable level. Overall, there is a shift towards using more equity, reducing the quantum of debt and leverage in deals.
We are also seeing increased use of deferred payments, vendor loan notes and/or retained shareholdings for sellers on transactions. This is enabling sellers to complete the deal at sustainable debt levels while also locking in value for themselves as vendors. There is also a higher percentage of deals involving earnouts, allowing buyers to pay less at closing while giving sellers the opportunity to gain more value based on future performance of the business.
3. Are private equity and alternative lenders playing a bigger role in funding transactions?
Private equity (PE) plays an increasingly dominant role in Irish M&A. There is an established and highly regarded network of local private equity funds along with increasing interest year on year from international funds attracted by the quality of Irish exported led businesses, Ireland's continued strong economic performance and status as an EU gateway.
When is right to bring in private equity on a deal? The decision to bring in equity is usually determined by 3 factors – growth potential of the company (which will typically involve in part growth by acquisition), capability of management team to deliver on that growth and the existing shareholders plan to crystallise value. Cultural fit is also really important to consider at outset especially in entrepreneurial businesses that are not used to reporting to external shareholders. By meeting with potential equity partners very early in the process you can get a better understanding on the cultural / strategic fit and we always recommend that companies make contact with “references” (investee portfolio companies) provided by private equity funds.
Non-bank lenders play a crucial role in the funding ecosystem by offering alternative credit to companies who may not meet traditional bank criteria. Given the reduction in the number of banking institutions in the Irish market during the financial crisis and their reduced appetite to fund certain industries/sectors post crisis, alternative lenders and their increasing prominences over the years have played a significant role in supporting emerging/scaling companies and indeed more leveraged businesses.
They have provided credit options to areas of the economy and for transactions that would otherwise go without. Non-bank lenders can often provide greater flexibility in their financing structures, adapting to a company's circumstances.
Non-bank lenders also include the likes of institutionally backed alternative credit funds and venture debt funders supplying non-dilutive financing to ambitious trading companies seeking to engage in M&A, accelerate growth, without giving up control or equity.
4. What are the most common mistakes businesses make when financing an acquisition?
Inadequate Due Diligence Scoping: This is when the buyer fails to thoroughly identify, assess, or verify material risk whether these be financial, operational, market, people, legal or IT security to name a few. It is critical you do your homework before you buy, not rush the due diligence process and ensure you have sufficient coverage and knowledge of the business before you close.
Common failures include relying solely on provided information- not verifying, challenging the data provided, over optimistic projections for the business and/or overestimating potential synergies, overlooking hidden liabilities, under estimating future capex spend, and neglecting cultural fit.
Underestimating the Funding Requirements of the Transaction: Failing to secure enough funding to cover the purchase payment, transaction costs and working capital needs to operate the business post-closing.
Choosing an inappropriate Financial Structure: At the outset of any acquisition, you need to establish your funding requirement and assess what type of funding support you need, which best fits your capital structure. For example, having an inappropriate debt-to-equity mix or having a high-interest financing structure which isn’t matched by the cash generation capacity of the business will cause future cash flow crunches and difficulties with funders.
To avoid these pitfalls its critical you get an experienced advisor on Board.
Content published in The Irish Times Corporate Finance Special Report.
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