Can the acquired firm finance itself?

Given that acquisitions are challenging, it is great when you can get a break. The one which we all seek, but rarely uncover, is when the acquisition can actually fund itself. While unusual, there are situations where this can work very well.

Most high growth firms face growth constraints which can often be best overcome through an acquisition. But at the same time, they are usually cash poor as they use whatever spare cash they have to finance their growth. Thus, while an acquisition may look attractive, they are unable to finance the investment. Finding an acquisition which can fund itself is thus a real win.

Perhaps the easiest strategy is to asset strip. There are many situations where businesses have idle assets which can be stripped out and sold, passing funds back to the business. An acquirer who focuses on the core of the business might find a number of assets which can be sold off to generate cash. A similar exercise can be used to sell off non-core parts of the business with those functions being outsourced.

There are also situations where the business is being acquired for one specific asset or capability and the buyer has no need for the rest. Once the key asset or capability is secured, the rest of the business can be sold with the proceeds being used to pay off the vendors. Sometimes this can be done with little impact on the vendor business. For example, the acquirer might be interested in gaining ownership control over a specific IP but might then license this back to the business as part of subsequent sale.

Anther technique which can be used is to sell and lease back assets of the business. Thus where the vendor has considerable land, building and plant, these may be able to be converted to a lease agreement so that the acquirer can release the value of the assets and yet continue with long-term use of those same assets.

Some businesses have significant cashflow which can be used to finance debt, especially where the vendors have not used this resource themselves to finance debt. This can be attractive to a lending institution where the acquirer is able to provide additional guarantees on the debt.

Cash generation may also be used in situations where gross margins can be substantially improved following the acquisition. This may occur where the acquirer can reduce input costs or enable prices to be increased. The additional margins may be sufficient to service increased debt which can be used to finance the acquisition.

In order to set up these types of deals, the acquirer will have to find a lending institution which will underwrite the deal until such time as it can be refinanced. For this to happen, the acquirer will have to be very certain of the post acquisition changes which can be undertaken to refinance the acquisition. But it is certainly possible if you find the right target firm.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia.