Capital Ideas | Corporate Finance Associates | Newsletter Q2 2017

 
Capital Ideas for Middle Market Businesses

Welcome to this issue of Capital Ideas, our newsletter dedicated to business selling, business buying and financial resources for mid-market companies.


Mergers and Acquisitions Financing

The Significant Role Financing Plays in M&A Transactions

By David Sinyard, Managing Director and Principal
Atlanta Office
Corporate Finance Associates

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The role that finance plays in mergers and acquisitions (M&A) is significant. When private equity firms recapitalize a company, a significant amount of the capital is originated in the form of senior debt. Banks and specialized finance companies focus on these types of transactions. As part of the recap transaction, the private equity firm will approach several lenders with the proposed deal, seeking the most aggressive response in terms of the amount that can be lent and the terms which include interest rate, term and principal repayment. Lenders will advance a multiple of EBITDA. Typically, the buyer will seek as much leverage as possible so that their equity check is limited. Let’s also remember that the interest paid is deductible as an expense of the business. For example:


Why is this of interest to a business owner who is trying to sell or recap his business? In addition to the private equity firm performing due diligence, the lender will as well. This means an additional burden on the business owner as the needs of the lender may differ from that of the equity provider. If the loan is from a bank, federal and state regulators may impact the transaction by limiting the amount of this type of financing that banks can provide. Regulators may impact the appetite of the various banks and may restrict them from originating these loans.

The negative impact of regulators has resulted in the expansion of non-bank lending sources. They come in a variety of forms –for example credit companies, Small Business Investment Companies (SBICs), Business Development Companies (BDCs), as well as private equity and hedge fund sponsored entities. Each of these has different lending parameters. As they are not regulated their deals can be more aggressively underwritten. The debt originated by these groups will be more expensive than senior lenders. There also may be some differences in the covenants required by the lenders.

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When should you Recapitalize your company?

 

By George A. Walden II, Principal
Houston Office
Corporate Finance Associates

You have survived the downturn and suddenly orders are coming in. But guess what, you have depleted your working capital and you're watching your cash go out the door ordering materials and adding personnel. This is often the period when companies fail because growth burns through their resources. To compound the issue, your bank is not very comfortable with giving you money because your earnings history hasn't been the best over the last business cycle. You're feeling good about just surviving and don't understand why suddenly you're not as bankable as you once were.

If you look at your balance sheet and you're a mess, you have too much debt and no recent history of strong cash flow, then you should consider a Recapitalization.

Per Investopedia: "Recapitalization is restructuring a company's debt and equity mixture, often with the aim of making a company capital structure more stable or optimal"

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Featured Acquisition - CFA San Antonio

The Situation:

The owners of River City Engineering were looking toward a retirement strategy and had explored an ESOP and a sale to a few of their key employees. They felt the ESOP was too costly to administer and their key employees did not have the entrepreneurial mindset to pursue a buyout. Having explored those options they turned to their attorney for guidance in a possible sale. Their attorney recommended that they meet with us to learn about the sale process and prospects.

The Solution:

We prepared a Marketability Analysis for the client that discussed their industry, how they measured up to peers in their industry, common deal structures, likely buyers and an expected price range. We included an overview of the sale process and a discussion of the value of creating competition. The owners elected to move forward with the sale of the company.

Our buyer outreach generated considerable interest from regional engineering firms both in Texas and other parts of the country. Interest in many cases was due to our client’s strong expertise in water and wastewater engineering. Additionally, our client’s Texas base provided an entrée to build out a comprehensive array of engineering services in one of the fastest growing regions in the US. Our client received numerous Letters of Intent and chose to accept an offer from Trihydro Corporation. In addition to providing an attractive economic package, Trihydro offered a strong and established firm with a corporate culture and fit that was extremely attractive.

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