If your company wants to make an acquisition you have two options: pay the vendors in cash or issue them with shares. However, in practice it’s not that simple. For a start, you have to consider a variety of different ways to raise the cash required: from your own cash flow, from lenders or by issuing shares to new or existing investors.
There are also different classes of equity that can be used aside from your shares. Convertible loan notes, which pay holders interest but give them no voting rights in the business, are popular at present. The terms can be negotiated to fit many different scenarios, such as offering different interest rates, levels of security or conversion rights.
A growing business will use a mix of these methods at any one time, depending on the particular acquisition being undertaken and whether the vendors are essential to the business going forward.
Buy and build
For some businesses, the principal means of growth is by acquisition. Take New Horizons, an operator of children’s homes, for instance. The Midlands-based company has ambitious plans to grow, by consolidating this sector and snapping up rivals. This strategy drew Dunedin Capital Partners to take a large stake in the business at the end of last year so they could support this growth.
Dunedin investment director Duncan Macrae says, ‘When we did the deal we over-funded the company because we saw the opportunity to make acquisitions as well as grow the business organically.’ The first such purchase, of Welsh operator Forward Approach for £3 million, has just been completed. ‘We did this by tapping a £5 million facility provided by Barclays Bank,’ he adds.
Macrae says that there was a race to fund the deal. ‘The banks are taking quite an aggressive attitude to funding the debt part of private equity deals at the moment. The company’s original banker was the Co-op but it did not come up with as good a package as others, who were offering more competitive rates.’
New Horizons can attract particularly good terms because the debt can be secured against the substantial assets, namely the property, of the children’s homes themselves. ‘Banks are also attracted by the flows of public money funding the homes’ operations.’
Macrae believes it is a good time for businesses to obtain debt to grow, as banks are keen to lend, even against the prospective cash flow of the target. ‘If you can get scale quickly without adding too much risk, then why not take advantage? However, it depends on the sector. Quite rightly, the banks are more cautious about funding the acquisition plans of consumer-based businesses such as retail and leisure.’
New Horizons is ‘actively looking at three more company acquisitions at the moment,’ says Macrae. ‘These may be financed differently, because one in particular is a larger transaction where we want to retain the middle management. So we may offer the vendors a mix of cash and equity.’
If you are contemplating a larger transaction then it may be worth considering a provider of mezzanine finance, independently of the banks. Mezzanine is the convertible loan element of a transaction. One of the largest such operators is Intermediate Capital Group.
The company has detected the banks moving into its space in recent years, offering innovative loans as well as traditional borrowing, usually called senior debt as it is the first to be repaid in the event of receivership.
Managing director Tom Attwood recently pointed out that ‘banks are being more aggressive in the amount of senior debt that they are prepared to offer’ as well as ‘reducing margins and increasing leverage for some mezzanine transactions’.
Intermediate has not funded many major acquisitions in recent years. The last one was a £14 million loan in May 2003 to assist greeting cards retailer Cardfair’s £45 million acquisition of Card Warehouse.
Debt finance may not suit every small company. A cautious entrepreneur might be reluctant to take on too much debt. A rise in interest rates or a slump in trading could be crippling.
However, there are alternatives to traditional borrowing worth considering, such as asset-based lending and invoice discounting against the target’s debtors. Banks again are now offering a complete package involving these elements, as well as mezzanine and senior debt.
AIM eases acquisitions
One of the major attractions of a stock market quotation is the ability to use paper to pay for acquisitions. AIM’s popularity is partly explained by the ease with which such deals can be done, due to its less stringent regulations.
Vendors are also happy to accept shares in an AIM-quoted company rather than fully listed paper, because after two years of holding AIM shares, the tax on any capital gain is reduced to just ten per cent. This is why loan notes are no longer used as much to pay vendors departing from the business.
AIM companies tend to offer their paper in a mixture with cash. Offering vendors some cash, while also locking them in with shares for some of the consideration, allows them the opportunity to take an interest in any potential upside of the combined entity. Getting the mix right is critical and usually revolves around the ongoing involvement of the target’s management.
A source at City broker Teather & Greenwood explains: ‘It really depends on the company and its ability to do deals, and also the strength of the balance sheet. We see a lot of companies raise lots of money at float, and then when they do a deal there is an element of shares issued as consideration. This is because management does not want to use up all of the company’s firepower on just one or two acquisitions.’
Raising money on AIM
Advisers will help a young, listed company tailor each deal for the specific circumstances of both the buyer and seller. If you are adamant that the acquired business’ management should stay on then advisers will tell you they really need to be tied into the future success of the enlarged business.
AIM companies pursuing buy and build strategies – where businesses in a given sector are acquired and brought together, creating a more tightly-run venture that can cut out duplicated costs – tend to do a string of cash and share deals. These have proved a roaring success for Straight, the recycling containers company that joined AIM at 80p towards the tail end of 2003.
A year after joining the junior market, Straight announced the £6.75 million acquisition of Leeds-based rival Blackwall, deciding to use a mix of £1 million in cash from existing resources and new money raised through a £5 million placing at 130p. In addition a further £750,000 of shares were issued to Blackwall’s vendors, who stayed on as consultants for six months.
‘Cash and shares seemed to work for the amount at which we were doing the deal,’ recounts chief executive Jonathan Straight. ‘Raising money from institutions was a lot easier than the first time we did the rounds, when Straight raised £1.5 million at float, because the amount was bigger and we had a bit of a track record by then.’
Completed this January, Straight claims the integration process was completed swiftly, with the key areas of the businesses – sales, marketing and operations, finance and IT – all brought together successfully. The Blackwall deal looks to have been a savvy one, where the mix of cash and shares worked.
Inter Link’s growth plan
A debt and equity mix appeals to many growing companies, among them successful AIM venture Inter Link Foods. ‘We’ve used a mixture of equity and debt to do deals on AIM,’ enthuses Alwin Thompson, chairman of the thriving cake maker, which joined the junior market at 110p back in 1998, and this January made its ninth and biggest acquisition to date, the £12.25 million purchase of Yorkshire Cottage Bakeries.
The takeover was funded through a combination of a £6.2 million bank loan, as well as proceeds from a £8.5 million placing of new shares completed a few months earlier. Some 1.65 million shares were issued to institutions at 515p.
When considering acquisition finance strategy, Thompson is adamant about the importance of ‘modelling’ the deal beforehand ‘from both a banking and an earnings per share position. It really depends on the size of the deal that you are doing. If you can make the acquisition within your existing facilities and without over-gearing yourself, then you would probably do just that,’ he asserts.
However, if it’s an acquisition on a grander scale, ‘and you would be pushing gearing too far, then you would use equity. Say it’s a £10 million acquisition and you raise £10 million of equity, then you would be diluting your shareholders and the deal probably wouldn’t enhance earnings. But if you raised £5 million of equity and used debt for the rest, then that would be a nice equity and debt balance likely to enhance earnings.’