In the first part of this article, I addressed the current strong environment for middle market M&A and the basic categories of buyers: private equity, strategic acquirers and family offices. How are these deals financed? Middle market company owners and their transaction partners have a range of different types of capital available to facilitate a transaction and create liquidity.
Financing Strategies for Mergers & Aquisitions
Senior Debt
Generally term debt with a low rate of interest available from banks, commercial finance companies and BDCs and often supported by company assets or company cash flow. This form of debt is generally tied to LIBOR or the prime rate or can be fixed as a corporate bond. (Range of cost: 5-10% APR)
Mezzanine Debt
(available as term debt subordinated in priority to senior debt but has priority over equity) Comes from specialized lenders or PE firms, often with warrants or other equity kickers. This debt is usually interest only and the term is for a period of 5 to 7 years. Usually used to recapitalize the company, buy out partners or for growth. (Range of cost: 12-18%).
Equity
Often issued in the form of common or preferred stock together. A PE firm or strategic buyer usually wants control of the company. The former owner will have a new boss and board of directors. For owners wanting to sell a business but stay on for a period of time as CEO, this may be an attractive alternative. The price range for a well performing company often begins at 5 times EBITDA and goes up from there, depending on the historical success and potential of the business. PE firms are generally seeking returns above 25% per year for the length of time they own the company.
Steps to Recapitalize Your Company
There are options for a company to generate capital for growth and provide cash to existing owners without giving up control of the business. There are PE firms that will purchase a minority interest in a company (at a lower multiple than for a sale, given that the PE firm will not gain control). A recapitalization is a approach to take advantage of current cash flow and position the owners of the company for a final exit in the future.
The steps are:
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Raise subordinated debt or minority equity based on current cash flow and use the proceeds to pay dividends to owners.
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Continue to reinvest profits in the company and grow the top and bottom lines of the financial statements.
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Position the company for a final sale down the road and sell 100% to a strategic buyer or PE fund, paying off the debt or retiring the convertible equity and distribute the remaining proceeds to the owners/sellers.
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If the company’s assets have grown sufficiently, subordinated debt can be paid off with less expensive senior debt, without having to sell the company.
This is the time to explore alternatives and take action, as there is a very good chance that the current, favorable climate for middle market M&A won’t last forever.
Newport Board Group is a partnership of board directors and senior executive leaders. We assist growth, middle market and private equity portfolio companies to navigate transitions and improve performance. Michael Evans is Managing Director of the Northern California practice of the Newport Board Group. Learn more or contact Michael here.
For more expert insight from Newport partners, download our whitepaper, "Growth-Oriented Mid Market Companies Need Independent Directors."
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