Acquiring a business in the small cap and lower mid-market space can be a highly lucrative strategy for entrepreneurs and investors seeking to expand their footprint. However, securing the right financing structure is crucial to ensuring a successful transaction while preserving cash reserves. This article explores how to minimise equity contributions by leveraging various forms of debt and deferred consideration, enabling acquisitions with little to no upfront equity from the acquirer.
Understanding the Financing Landscape
For businesses with an EBITDA between £500,000 and £5 million, acquisition financing typically involves a combination of debt, vendor finance (deferred consideration), and, in some cases, an equity contribution from the buyer. The choice of financing instruments depends on the financial health of the target business, the industry, and the risk appetite of lenders.
Minimising Equity Contribution
One of the key objectives for acquirers is to minimise their upfront equity injection. This can be achieved through structured financing that maximises the use of debt and deferred consideration.
1. Asset-Backed Lending
A powerful tool for funding acquisitions with minimal equity contribution is asset-backed lending (ABL). This type of financing allows businesses to unlock value from tangible and liquid assets, such as:
Invoice Finance: Utilising the target company’s outstanding receivables as collateral to secure funding, providing an immediate cash flow boost.
Asset Finance: Leveraging fixed assets (e.g., machinery, vehicles, equipment) as security for loans.
Commercial Mortgage (Owner-Occupier): If the target business owns property, financing can be structured around a commercial mortgage, reducing the need for upfront capital.
With ABL, an acquirer can often secure full funding for an acquisition, eliminating the need for a personal equity contribution.
2. Deferred Consideration (Vendor Finance)
Deferred consideration, also known as vendor finance, is an arrangement where the seller agrees to receive a portion of the purchase price over time rather than upfront. This approach benefits both parties:
For the buyer: It reduces the immediate capital requirement, easing the financial burden of the acquisition.
For the seller: It can provide a smoother transition and potentially a higher total consideration based on future business performance.
Structured correctly, vendor finance can play a significant role in closing deals with little to no acquirer equity.
3. Cash Flow Lending and Equity Contribution Requirements
If neither the acquirer nor target comapny has an unencumbered trade debtor book or tangible assets to leverage, then the acquirer would need to explore a cashflow loan (typically unsecured lending based on future business earnings of the combined entity). Lenders will generally require the acquirer to contribute at least 20% or 30% of the Day-1 consideration in hard equity. Cash flow loans are assessed based on the financial strength of the business rather than specific assets, making them riskier for lenders and thus necessitating a meaningful Day-1 financial commitment from the buyer.
Structuring the Right Deal
The optimal financing structure depends on several factors, including the acquiring company and the target company’s asset bases, EBITDA and cash flow stability, and the seller’s willingness to accept deferred payments. A successful acquisition financing strategy might involve:
Invoice Finance + Vendor Finance: If the target company has an unencumbered trade debtor book and invoices B2B customers in arrears with average DSO (daily sales outstanding) of 30 days or more, then this combination can allow an acquirer to fund a deal primarily through the acquired company’s own working capital.
Asset Finance + Commercial Mortgage: If the target company has valuable unencumbered tangible assets and property, these can be leveraged to raise capital without requiring equity input from the acquirer.
Cash Flow Loan + Equity Contribution: When future earnings potential is strong, but tangible assets are limited, a mix of equity and cash flow lending can be a viable route.
Q&A: Key Financial Terms Explained
Q: What is EBITDA?
A: Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA) is a measure of a company’s operating performance, often used to assess profitability.
Q: What is Asset-Backed Lending (ABL)?
A: A type of financing where loans are secured against tangible assets like receivables, equipment, or property.
Q: What is Invoice Finance?
A: A form of ABL where a company borrows against its unpaid invoices, providing immediate access to working capital.
Q: What is Deferred Consideration?
A: A portion of the purchase price that is paid to the seller over time, often structured as instalments based on agreed terms.
Q: What is a Cash Flow Loan?
A: A loan provided based on the expected future earnings of the business rather than secured against assets.
Q: What is an Owner-Occupier Commercial Mortgage?
A: A mortgage used to finance the purchase of commercial property that will be occupied by the business itself.
By strategically leveraging the right mix of financing, acquirers in the small cap and lower mid-market space can structure deals that require little to no personal equity while maintaining financial flexibility. Understanding the available financing tools is key to executing successful acquisitions and driving sustainable business growth.
Enquiries
For further information, please contact info@langdoncap.com
About the author
Sabbir Rahman is Managing Director of Langdon Capital. He has held prior roles with Morgan Stanley, Lazard and Barclays Investment Bank. He has executed over £60 billion in notional value of debt, equity, M&A and derivatives transactions with global corporates, private equity funds and financial sponsor groups.
About Langdon Capital
Langdon Capital assists small-cap and lower mid-market companies with EBITDAs between £1 million and £20 million in strategic transactions including M&A, disposals, debt refinancings, debt restructuring and debt and equity capital raises from a network of alternative investors including private equity firms, venture capital funds, corporate VC arms, family offices, venture debt funds, private credit funds, UHNWIs, real estate funds and hedge funds.
We also assist SMEs and lower mid-market businesses, with revenues between £250,000 and £50 million, and property developers and property investors, to obtain commercial finance ranging from £26,000 to £200 million, from a panel of over 130 specialist lenders and institutional investors. Clients can be profitable or unprofitable, solvent or insolvent, but they must have at least a 2-year trading history.
contact info@langdoncap.com | visit www.langdoncap.com
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This is not financial advice or any offer, invitation or inducement to sell or provide financial products or services or to engage in any form of investment activity.
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