When a company wishes to acquire another company, a subsidiary or division of another company, or assets of a company that is narrowing its focus or liquidating, financing is often required. Securing the right financing and ensuring that the terms are favorable can determine the success or failure of not just the acquired entity, but the acquiring company as well.
Depending on the needs of the acquiring company and other factors, financing may come through a traditional loan agreement, a hybrid loan / equity arrangement or a private investment. The decision-making process and the search for the right source of funding may be daunting, but an experienced commercial lawyer can help.
Acquisition Financing through a Conventional Lender
The lender’s analysis with regard to acquisition financing is twofold. The borrower / acquiring party’s creditworthiness is, of course, at issue, but good credit will generally not be sufficient to secure a loan. Rather, the lender will also look to the viability and cash flow of the entity being acquired. While projections will play some role in this analysis, a documented history of positive cash flow will carry more weight. Thus, substantial information about the entity being acquired will be required at the loan application and approval stage.
An attorney experienced with various types of acquisition financing can help you determine whether or not a conventional loan is the best option for your acquisition, assist you in negotiating for favorable terms, and ensure that you fully understand the obligations and restrictions created by the terms of your loan.
Mezzanine Financing
Mezzanine financing operates much like a conventional loan except that the terms of the agreement permit the lender to convert to an equity or ownership interest in the acquired entity in the event of default.
One key advantage of mezzanine financing is that interest on the debt is tax-deductible. The borrower also has more options in terms of writing scheduled, interest payments into the loan or requesting deferral of interest payments if necessary. The downside, however, is significant: the purchasing entity risks diminished control over operations and may ultimately pay quite a bit more than the anticipated interest if the lender claims equity.
Given what is at stake in a mezzanine financing agreement, it is essential that you fully understand all the risks and ramifications of the loan and negotiate the most favorable terms possible. An attorney experienced in mezzanine financing deals and other types of acquisition financing may be your best resource.
Venture Capital
Where the purchasing entity is unable to obtain financing through a lender or does not want to assume the full risk of the acquisition, private investment is an alternate option. Venture capital is frequently the source of funding for a transaction that might not qualify for a traditional or even mezzanine loan, usually due to an inability to establish a history of strong performance. However, in exchange for access to capital, the purchasing entity gives up a degree of control. While specific terms vary, venture capitalists typically require some say in at least high level decisions regarding the company.
When negotiating a private investment as a source of acquisition funding, there is potentially more at stake than in any other financing scenario. Although the investment will virtually always be non-recourse, meaning that the acquiring entity is not responsible for repayment of the investment should the company fail to pay off, the agreement must be carefully negotiated and drafted to protect control of the business.
Talk to an Experienced Acquisition Financing Attorney
When determining the best approach to financing the acquisition of a company, subsidiary, division, or the assets of a liquidating business, careful consideration is required. The right option will depend on several factors, including:
- The creditworthiness of the acquiring entity
- The track record of the acquiring entity
- The direct investment of the acquiring entity
- The priorities of the acquiring entity
Experienced acquisition financing attorneys, like the ones in our firm, can provide the guidance you need to choose the best option for your circumstances, as well as:
- Assist in assembling the documentation necessary to secure favorable financing terms
- Negotiate the terms of a loan or investment deal
- Review loan documents and advise you regarding risks and ramifications
- Draft or review investment contracts
Before you take an important step such as structuring an acquisition of an existing company or a subdivision of an existing company, make sure that you have the information, support and guidance that you need to make the best decisions for the future of your organization. Contact KPPB LAW today.
