Acquisition finance:

What is it and how is it used?

Acquisition finance or acquisition financing in the UK is a type of corporate finance used by entrepreneurs, SMEs and large corporations looking to buy another business – or buy out the owners and stakeholders of a business they already work at. These corporate business transactions are also often referred to as ‘mergers and acquisitions’ (M&As).

In this guide to acquisition finance, we cover:

1. What acquisition finance is
2. Why businesses make acquisitions
3. How acquisition finance works
4. The different ways businesses can finance an acquisition
5. How OakNorth has supported successful UK businesses in 2022 with management buyouts (MBOs) and mergers and acquisitions

Acquisition finance, also sometimes known as M&A financing, is a broad term often used to describe the capital raised for the purpose of buying a business, either in full or partially by purchasing a percentage of its assets and shares. This corporate funding is typically provided by banks or alternative lenders in the form of debt finance which is essentially a business loan.

It can also be raised through equity finance – where a business sells shares to new or existing investors to raise money. It’s not uncommon for businesses to finance an acquisition by raising senior and junior debt finance and equity finance.

Businesses buy other businesses for a range of different reasons – perhaps they want to create a strategic partnership by combining the force of more people, technology, intellectual property (IP) and operations. Or maybe there is a unique opportunity to purchase a competing business within the same sector to obtain their property, data, talent and other tangible or intangible assets.

Mergers and acquisitions that involve taking over competing businesses can happen more frequently during periods of economic recession or downturns. This is because businesses that are struggling with cash flow and cannot survive may be willing to sell at a lower price.

This was the case in the UK during the coronavirus pandemic: the ONS reports that the average merger and acquisition deal value in 2021 for the ten highest deals (£3.3 billion) was significantly higher than the ten highest deals in 2020 (£0.6 billion).

Economies of scale

Many businesses use acquisitions to increase their efficiency at scale to produce more of something faster at a lower cost to the business. This naturally helps increase profit margins and promotes faster growth

Reach new global markets

Instead of branching out in a new country from scratch, which can be expensive, time-intense and risky, businesses can penetrate new international markets and gain global reach by bringing preexisting businesses within those companies

Bring in new talent

Recruiting the brightest minds isn’t an easy task, especially if you’re looking for senior hires with years of industry-specific expertise. Many businesses consider mergers or acquisitions to gain access to skilled new departments they require to grow, such as Product or Engineering teams.

Increased costs

When a business takes on another business, not only does it have to pay for it, but it also must shoulder all the running and operational costs that come with it – as well as any outstanding debt it may have. Businesses making acquisitions will forecast the long-term cost of an acquisition, including things like the increased headcount and salary costs, increased supplier costs as well as the debt they may need to take on to make the purchase.

Risk of inefficiencies

Most businesses make acquisitions to increase their efficiency – whether it’s to move it to new markets faster or to bring in new departments from scratch. Yet in some cases, they can cause the oppositive effect, with a crossover of roles and duplication of work efforts, which can also cause siloed teams that struggle to fuse. This is seen more frequently across mergers, where the target business, once successfully purchased and approved by any regulatory bodies, can be absorbed into the business that bought it.

Misaligned goals

Purchasing another business is no small feat. It takes a lot of determination to make an acquisition a success, so there needs to be the right motivations in place. The disruption it can cause to employees on each side can be a huge risk. If there is a misalignment in the wider vision and mission, employees from the acquired company are likely to move on to another role. This is especially risky for acquisitions that are made as hiring strategies.

When a business decides that it wants to acquire another business – typically after undertaking extensive due diligence and performing a thorough strategic and financial analysis, it will usually look to perform what is known as a ‘leveraged buyout’ (LBO).

An LBO is a specific term for an acquisition which uses borrowed ‘leveraged’ money to complete the transaction. They’re usually secured against the assets and cash flow of the target company and the purchasing company.

Usually, most of the money for the acquisition will come from bank debt. For example, if a business is purchasing another business at the price of £150 million, it may take out senior debt finance for £100 million, secondary ‘mezzanine’ debt for £30 million and put down £20 million in equity.

Financing an acquisition using debt as the primary source of capital can be more cost-effective than using equity. This is because the interest repayments on debt made by the business reduce the level of income tax, whereas dividend payments do not. Additionally, the actual cost of debt is also usually cheaper than equity.

If an LBO uses private equity, it can include a financial sponsor – usually a private equity firm, or hedge fund. In an LBO with a financial sponsor, the private sponsor will then usually create something called a special purpose vehicle (SPV).

This is a separate legal entity distinct from its parent company. It’s created specifically to undertake corporate transactions such as acquisitions because it separates the parent company, its assets, balance sheets and any liabilities from the separate entity. The SPV is considered a new isolated business, so it becomes isolated from any financial risk or insolvency that the parent company may encounter.

Depending on the size of the transaction and the price of the acquisition, there could be multiple sources of finance in both equity and debt which can often make the process quite complex.

However, where senior debt is concerned, OakNorth specialises in fast financing – we can usually have the funds in your accounts in weeks rather than months and they’re delivered directly by experts. We work closely with ambitious businesses, helping them complete mergers and acquisitions, no matter how complex the structure is.

Businesses use a range of different techniques to raise capital for an acquisition. Often a merger or acquisition will be financed through different parts of the corporate capital structure – so a mix of debt, bonds and equity. Here’s a short breakdown of the most common forms of acquisition finance in 2022:

Debt financing

Debt financing, also known as a business loan or business financing is when a business borrows cash from a lender such as a bank which it uses towards the acquisition cost. The business then pays back the debt amount along with the agreed interest and fees agreed upon. It’s typically a cheaper source of finance than equity, as any interest paid on monthly repayments is tax-deductible, as well as the coupon payable on debt usually being lower.

Businesses looking for loans will need to provide a solid business plan and prove they are financially strong enough to pay back their debt and interest in its entirety. This means that businesses with a low EBITDA, poor credit history or low profit margins may find it harder to access debt.

Equity financing

When it comes to financing a new acquisition, business owners can sell equity to raise cash for the purchase. Businesses will usually go through a funding round with private or public investors to raise a portion of the capital they need to make the deal happen. Depending on the amount of funding needed, equity financing can eventually lead to a loss of control for the original owners.

Stock swaps

A stock swap is the exchange of one equity-based asset for another. Businesses can use stock swaps for mergers or acquisitions to retain as much liquidity as possible and hold on their cash reserves. In an acquisition, shareholders would swap their stocks in the target company for stocks in the acquiring company. For this to happen, both companies will need to undertake a valuation to determine a fair swap ratio.

OakNorth offers business acquisition loans designed especially for ambitious businesses looking to expand their reach with new talent, products and global markets. We offer term debt, revolving lines of credit, debt refinancing and other umbrella facilities from £1million up to tens of millions, that make leveraged buyouts easy for entrepreneurs looking to move fast on their next purchase. To speak to one of our lending experts to learn more, fill out this short online form.

Strengthening leading global textile firm, Europa Wools new retail offering

Europa Wools is a UK powerhouse. The family-owned business, run by Managing Director Richard Morsely and his sister Gina, after succeeding their parents, supplies over 1 million kilograms of raw textile materials to the global wool trade every year. With over 30 years of experience and specialisms in British, Australian and New Zealand wools, 2022 saw them take on a new challenge – strengthening their retail market offering. OakNorth helped Richard buyout his sister’s share in Europa allowing her a seamless exit with a £2.1m acquisition loan allowing him and his management team to focus on unravelling their expansion plans.

The covid-19 pandemic allowed Richard Cullen, CEO of Cullen Wealth – a financial advisory firm based in Cheshire, to refocus on his business goals and future milestones. As well as his CEO role, Richard owned half of the business at the time, but to effectively execute his visions for the firm he knew he’d soon need full control.

He came to OakNorth for fast financing that would help him seamlessly buy out his shareholders and continue his path to growth. As founder-led entrepreneurs, Richard’s plans not only resonated with us but made us proud to support his mission. We provided Cullen Wealth with a bespoke £4 million business loan which saw him become the full owner of his financial firm and keep supporting over 3,000 clients

So, whether it’s taking back full control of a current business or staking your claim on another, we’re here to provide fast access to capital for smooth transactions. Our loans are built by entrepreneurs, for entrepreneurs which means we speak like business owners, not bankers. That means no rigid systems, blanket decisions or outdated cookie-cutter approaches. Just flexible debt for your next bold business move.