Acquisition finance

What it means

Acquisition finance is a loan or mix of funding a buyer uses to pay for another company, that is, an acquisition. It is to be repaid from the future cash flow of the acquired company or the combined group.

The bank assesses not just the buyer but above all the target: its profitability, revenue stability, leverage and the risks found in due diligence. It typically funds part of the price, and the buyer must cover the rest with equity.

When the debt share is high, the deal is an LBO. Besides a bank loan, mezzanine finance, a vendor loan or a deferred part of the price in the form of an earn-out can be used.

How it works in practice

Banks usually require a lien over the acquired shares, security over the target's receivables and accounts and a group guarantee. The loan agreement includes covenants such as a maximum net debt to EBITDA ratio.

After the purchase, a merger of the buyer with the target is often considered so that interest can be covered by the target's profit. Tax authorities scrutinise such structures, and interest deductibility limits apply.

In the accounts, arrangement fees must be spread over the life of the loan, and covenant compliance should be checked at every close.

What to watch out for

The biggest risk is overestimating the target's future profits. If revenue falls after the deal, the company may not manage repayments, and a covenant breach can make the loan immediately repayable.

Financial assistance rules also matter: a target joint-stock company may not give the buyer security for the purchase of its own shares, or the arrangement may be void. The structure should be prepared with a lawyer.