The financing of the acquisition of a mid-market company generally takes several forms. For example, a company with an enterprise value of $10 million might expect the buyer to invest $2 -- $5 million of its own funds. Sometimes the buyer will be able to invest even less, depending upon its banking and mezzanine relationships. A bank can reasonably be expected to provide senior acquisition debt as a multiple of cash flow. For example, if the cash flow on a $10 million company is $2.5 million, a bank might be expected to loan 2 -3 times this amount. As the cash flow increases so does the multiple that banks could be expected to lend. Shortfalls in the cash required to close the sale are generally made up in the form of mezzanine and/or seller financing.
Senior Debt. Senior debt typically has the lowest cost of acquisition capital other than line of credit financing. Sources include commercial banks, credit companies and insurance companies. Typically, 50% to 70% of the acquisition price takes the form of senior debt. A term of 5 years would not be unusual. The amount a bank will be willing to loan will also be affected by the dollar amounts of accounts receivables, real estate and other hard assets, as well as inventory.
Mezzanine. Mezzanine financing has a combination of characteristics of both equity and debt financing. It embodies the middle layer of financing and usually takes the form of subordinated debt, which senior debt holders, traditionally major banks, view as equity. When traditional debt has been maximized, mezzanine financing can provide the additional capital required. Mezzanine financing is comprised of a term loan and an equity-like participation (e.g., stock or warrants).
Many times, mezzanine financing is used for one-time major events during a company's life: acquisitions, expansion or business successions. Because mezzanine capital has more of a risk than senior debt, the lender will require a higher rate of return in the form of interest and equity participation. The idea is that the owners of the company will be more than sufficiently rewarded by the increase in the value of their company. Mezzanine capital can be an integral component of the financial structure for a growing/restructuring company.
Mezzanine financing is most beneficial to a mid-market business that has a strong cash flow, a proven track record, strong management, sales greater than $10 million and debt that is a reasonable multiple of cash flow. Including mezzanine financing can reduce the overall cost of capital and provide requisite growth capital for a mid-sized business.
Seller Financing. It’s often smart for sellers to finance a portion of their own business sale. Seller financing can help achieve the highest possible purchase price. If the seller is confident about his business and the buyer a seller finance can be a great investment. Sometimes, banks will only participate when there is seller financing to indicate that the business is sound in the eyes of the seller. But, even when a seller doesn’t want to, the realities of the sale often force seller financing.
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complete the transaction.