Asset-Based Lending for M&A Finance - Ted Ettershank, Lloyds TSB

Acquisitions can make or break businesses for many reasons. Positioning, culture, performance: all these factors are crucial to the chances of a target business bringing success to the acquiring company, writes Ted Ettershank, managing director, Lloyds TSB Commercial Finance.

Having reached the stage where an acquisition makes sound strategic sense, the management of the acquiring company must make another decision that could help or hinder the business for years to come: what type of finance should it use? The answer often hinges on what type of business it is, but, as far as many firms are concerned, there are only two main options: backing from venture capitalists (or equity investors) and the issuance of shares.

KEEPING CONTROL

These types of finance make perfect sense in many cases, but equally, there is no question that they also bring their own problems. For instance, any management team endeavouring to retain total control of their business should be fully aware that venture capitalists or equity investors are rarely content to assume a passive role. Most will expect a seat on the board, or at least an active role in the day-to-day management of the business. Their demands – always made with an exit in mind – may not be easily reconciled with the management’s vision of the future.

FINANCE THROUGH SHARE ISSUANCE

Of course, the management team may instead decide to issue shares to raise finance. Like the other options, it is a well-trodden path, but could dilute the value of the company’s shares, something that runs counter to its aspirations. In addition, there will be pressure to pay dividends on those shares, thereby curbing the management’s room for manoeuvre.

If none of the above particularly appeal, management could plump for a bank term loan, linked to the profitability and cashflow of the business. A traditional route this may be, but the downside is that the company will, as with many other forms of lending, be required to repay the capital as well as the interest.

INTACT ASSET BASE

With asset-based lending, there is no such requirement. Indeed, the asset-based lender only requires two things of the borrowing company: that its debt is serviced and that its asset base remains intact. There are seldom further demands. The management of the business will not have to give up any equity, nor will it have to answer to financiers, who might bring pressure to bear on the company to move in a new direction. Certainly, there will be no extra seats on the board.

ASSET-BASED LENDING

Asset-based lending is playing an increasingly important role in M&A, largely because it allows businesses to access funds based on a mixture of the outstanding sales ledger, plant and machinery, property and stock. These funds can then be used to plug the gap between what the business can afford to inject into the acquisition and what the bank will lend. Businesses can even use the assets of the target company to leverage against the required funds.

BREATHING SPACE

For the same reason, asset-based lending is increasingly being utilised to fund management buyouts and management buy-ins. While not suitable for all businesses – particularly asset-poor, cash-rich firms – this form of lending appeals to management teams because it can assist not only in the purchase of the business but also for ongoing funding, which offers more breathing space in the difficult early days.

Crucially, it can also be used in conjunction with other sources of financing. How this is done simply depends on how the management team wants the balance sheet to be structured, but either way, few other sources of M&A lending offer this flexibility.

Acquisitions should be the natural evolution of a healthy business, but the right deal can still be hampered by the wrong financing arrangement. The most obvious choices are by no means always the best.