By Odhiambo Ocholla
In today’s economy, securing financing to purchase a business has become a full time job, and there’s no guarantee all the hard work will pay off in the end. When companies seek acquisitions, there are a number of financing options, such as cash, debt, stocks or any combination of those items.
The ultimate financing structure depends on many factors, including the objectives of the buyer and seller, the state of the credit and capital markets, operating and cash flow characteristics, industry dynamics and purchase price.
Before to determine a financing solution, you must understand the historical earnings and current trends of the business you wish to acquire. Calculating the true earning power of a business can be a difficult task.
Most business owners maximise tax strategies to minimise reported earnings so they pay fewer taxes. Therefore, when a prospective buyer looks at the net income, they may not be seeing the whole story. How can you avoid the failures that can follow an acquisition?
Hire professionals and line up the money
First hire a professional. There are some things that should never be done without professional help. Buying a business is definitely one of them. Professionals will help you research the industry, qualify the best options and structure the final deal. Another strategy in acquisition financing is to line up the money. One of the worst things you can do when looking to buy a business is to find one you really like and then, during the beginning of the negotiation, you admit that you don’t yet have the money to make this deal work. Nothing will kill a deal faster than that. Financing can be sought from commercial banks, who can help set up parametres like debt load, tangible assets before providing funds. Existing investors can also serve as source of financing acquisition. An established business has a track record and can hopefully be run better by an experienced entrepreneur.
It’s advisable to focus on keeping the players involved. When it’s the performance of people that will define the future success of a deal, the deal must focus on how best to keep these key players motivated and contributing.
Structuring an earn-out
Always structure earn-out — a contractual provision stating that the seller of a business is to obtain additional future compensation based on the business achieving certain future financial goals. No matter how you structure a deal, it should follow a logical path to the final structuring. The first step is to agree on a valuation. This, in essence, is the fair market price all parties feel the company would be worth if it sold today.
Each side will probably have their own set of experts crunching numbers to justify their position. Find some common ground and agree on a compromise.
The next thing you have to do is agree on an earn-out. This is often the hardest part because, to do this effectively, both sides must agree on several points i.e. the amount of the down payment, parametres that will define how much of the remaining payment will be made and when.
The reason deals are done this way is because the factors that determine the valuation may change if the company fails to perform to par after it’s acquired.
Let’s say you buy a company that says it’s doing Sh500 million per year in sales with a Sh200 million profit line, but in the first year after you acquire it, the company only does Sh300 million and has a loss. That’s why earn-outs are important.
They protect the buyer and, if structured properly, give the seller a chance to get a higher price if they can meet or exceed certain goals.
—The writer is an Investment Banker. Email: nyabolla@gmail.com
