Playing Ball With Financiers

For the vast majority of leveraged buy-outs (LBO) deals, financiers — bankers and lenders — are key.

If you manage to acquire a business using just the surplus cash, seller financing and potentially earn-outs, then you don’t need to go to the financial markets to fund a closing payment.

But the majority of deals I (and our students) have personally closed have required some external financing.

External financing can be debt-based (asset-based lending, cash-flow lending, SBA 7(a), etc.) or equity-based. There are some nuances between debt providers and equity investors, but most external financing is debt-based, so that’s what we will focus on today.

When playing with financiers, it typically happens in three phases.

Phase 1: Before you find a deal

Before you even begin deal origination, it’s a great idea to start talking to financiers. There are two major reasons for this.

First, financiers have access to deal flow thanks to their existing portfolio of businesses. And we know that 80% of sellers communicate with stakeholders (financiers, wealth managers, CPAs and attorneys) prior to listing a business for sale.

Second, when you start building financier relationships early in the business buying process, you can get comfort letters or emails in advance that confirm potential backing for suitable deals.

This is MASSIVELY powerful if you ever get stuck with a business broker (or seller) who will not release financial information—or even allow you to look at the business—until they are satisfied you have some degree of financial backing.

Phase 2: Once you have found a deal, but prior to the closing process

Once you have found a deal, and have agreed to a deal structure with the seller, it’s worth sounding out your chosen financiers for expressions of interest (EOI), or funding indications.

While this is not a fully-baked term sheet, an EOI is often still a critical part of the same process.

You see, after agreeing on an offer, the next stage is to sign a letter of intent (LOI) giving you exclusivity to buy the business within a certain timeframe. At that point, most sellers (and brokers) will want to see that you have the financial backing to make the closing payment and cover fees, working capital increases, etc.

Only then will you secure the term sheet—a critical stage in any deal. It indicates the financier has been to its credit board and gained approval to do the deal.

The term sheet will often detail what due diligence will be carried out, the terms of the financing (length, interest coupon, repayment penalties, fees, etc. and the timeline to closing.

Sharing the term sheet with the seller conveys confidence you can close the deal, since a financier has put its trust in you and the business.

Phase 3: The closing process when ownership transfers from the seller to you, the new owner

As you go through deal execution to close the deal, either you, your attorney or your CPA will be in daily contact with your financing partners.

The financier will be carrying out all the financial, commercial and legal due diligence and fine-tuning the financing package based on the provision of business information.

Every lender will require different things, so make sure you continue to work on your buyer-seller relationship — sellers can get annoyed by the constant requests for information. Getting the seller’s CPA and attorney involved in the data mining process is key.

Information Financiers Will Require

All financiers are different. Requirements can even vary between SBA-approved lenders.

Here’s the MINIMUM level of information you’ll need for ALL lenders and investors from your acquisition target:

• Last three years of accounts and tax returns
• Last full year’s monthly income statements and balance sheets
• Current year’s (to date) monthly income statements and balance sheets
• Current full-year forecast if it’s available ( you will often find most small business owners don’t forecast)
• Business plan (again, don’t be surprised if the seller doesn’t have one)
• Current balance sheet (within 45 days), so you can see the immediate positions of working capital, assets and liabilities
• Revenue by product, customer and even channel to market (if available)
• List of employees, their functions, salaries, benefits and tenure (this may be supplied in an anonymous way).

Binding Covenants

In all forms of financing, after the deal has been made you agree upon covenants. Simply put, these are the financial rules by which you agree to run the business.

Financiers will monitor financial performance (monthly or even quarterly). If you fall afoul of the financial covenants, there may be additional charges, increases in interest payments, or (for consistent, serious breaches) the calling of the loan or other form of financing.

A classic example of a covenant is the minimum cash balance.

For example, say you agree to have a minimum of $100K inside the business at each reporting period. Knowing this, you can manage the working capital inside of the business to make sure you hit that threshold.

For most LBOs, financing is key — it controls the closing payment for your deal.

The keys to success are to build relationships with financiers early, get the data you need for a financier to make a sound lending decision… and lean on your deal team (CPA and attorney) to manage the deal to completion.

Until next time, bye for now.