Traditional debt providers are turning away from risk on larger deals, leading to a general slowdown in transactions. Although advisers claim the mid-market is showing a certain amount of resilience to global economic uncertainty, deals worth £250-£500 million have clearly been dented.

A report from investment bank Baird reveals that the value of UK M&A activity in the first quarter was £2.9 billion, down 60 per cent from £7.3 billion compared with the previous year.

“Smaller deals in the £10-£100 million are more likely to get through than larger ones. If banks can get comfortable with the company, the terms they are putting forward and take it on their own balance sheet without having to syndicate it, then it’s much easier,” observes Stuart Marcy, director at Smith & Williamson Corporate Finance.

“It starts to get more difficult when deals get up to a size where banks have to potentially syndicate. Trying to sell down some of the debt package you have put together into the syndication market is very difficult at the moment. These are the deals that are less likely to happen.”

Other advisers share Marcy’s views, observing that more banks are sharing the risk upfront, whereas previously they would have taken on the debt and then distributed it.

Innovative funding

The reluctance of debt providers to take syndication risks is driving down deal numbers, but those transactions that are getting through are seeing different funding structures. Marcy notes a rise in the use of integrated finance and asset-based lending, in addition to the rise of mezzanine financing to fund smaller deals.

“A number of players are offering ‘integrated finance’ in the lower mid-market, such as Close Brothers Growth Capital, Close Venture Management and Icelandic Bank Glitnir. It helps them because they are able to put together entire funding packages off their own balance sheet from the beginning.”

Fewer leveraged deals

Another strong indication that funding structures are changing is the unusually high percentage of equity currently being pumped into deals by buy-out houses. Debt syndication problems, together with vendors set on keeping completion risks to a minimum, have seen a change in tactics from private equity investors.

Jon Breach, M&A partner at BDO Stoy Hayward, agrees. “A number of the private equity houses have been able to complete deals by essentially writing the whole cheque themselves and then organising the leverage post-deal.

“There are a few houses, such as European Capital that have been doing this for some time, and we are now seeing the more traditional private equity providers going down this route to remain competitive.”

In the mix

On the debt side, Marcy observes more complex funding packages. “ABL and property-related tranches are being mixed into packages as players try to get hold of more security within their overall lending.”

Figures released by the Asset Based Finance Association (ABFA) confirm this, showing an upswing in the use of asset-based finance, primarily driven by public companies turning to invoice finance to fund buy-outs, acquisitions and expansion plans. The industry body claims ABLA members were lead financiers on deals worth £1.2 billion in 2007 compared with £918 million in the previous year.

Breach adds: “ABL is great for these sorts of situations because it scales with the business. With a fixed-debt instrument, the business has to perform at or above the parameters that are being fixed. If it out-performs or under-performs, it’s not necessarily ideal. With ABL, when the business scales up and needs more working capital that’s provided by the facility.”