Getting creative with acquisition financing

M&A activity is one of the only reliable avenues to growth available to business owners during the current economic uncertainty, with consumer sentiment low, inflation high and costs for raw materials, labour and energy all continuing to rise.

The problem is, amid such uncertainty, the traditional avenues for securing the financing required for M&A activity are more restricted, with lenders such as banks tightening their financing conditions due to the heightened levels of risk present during an economic downturn.

While that doesn’t mean that those funding options are a total non-starter, business owners may also need to get creative if they are to raise the financing they need to develop an M&A strategy, target deals and grow through acquisitions. Here are three non-traditional financing options that could prove valuable to buyers in the current market.

P2P financing
Even in times of economic growth, banks and other traditional lenders are often more reluctant to lend to SMEs and this has been a major factor in the growth of peer-to-peer (P2P) lenders. Some P2P lenders offer dedicated financing services for SMEs, with products including funding for acquisitions, mergers and MBOs.

Compared to traditional lenders, P2P lenders often have less stringent credit checks, enabling younger, growing companies to borrow without the need to provide years of immaculate financial statements. This more relaxed approach also means that P2P loans will typically be made available more quickly, enabling buyers to commence with their acquisition strategies sooner.

P2P lenders may also prove more flexible to the individual requirements of different SMEs and be able to tailor their offerings accordingly, in contrast to traditional banks which will typically have set-in-stone policies and set products. P2P lenders may also be able to offer lower interest rates and a smoother overall administrative process.

However, there are of course drawbacks to this kind of financing model. In the wake of the COVID-19 pandemic, some P2P lenders have said that they will require a significant degree more security in order to facilitate acquisition loans. Meanwhile, the market remains relatively new and, as a result, less well-regulated than the traditional banking sector. This means that buyers should do as much research as possible to ensure that they get their financing from a legitimate, trusted lender.

Seller financing
Seller financing, in a nutshell, is a deal structure through which a seller provides a form of loan with legally binding terms to a buyer to help facilitate a sale of their business. The buyer typically makes a down payment, followed by monthly payments at a pre-agreed interest rate over a set timescale until the repayment is fulfilled, at which point the transaction is complete.

There are several benefits to this kind of approach, most notably providing buyers with a chance to acquire a business at a minimal upfront fee. It can also help to minimise the often-costly involvement of middlemen and lenders, enabling a more direct channel between buyers and sellers.

Of course, there are other considerations. For one, if the acquisition proves unsuccessful, then a buyer may find themselves locked into a costly repayment plan that may not even be satisfied by the business being placed into administration. Even if the acquisition is successful, moreover, the cost of repaying the financing on a monthly basis could impact the firm’s bottom line for a considerable time.

Another type of financing that might be offered by non-traditional lenders is microfinancing, which consists of small loans with short repayment periods. As with P2P loans, microfinancing can provide more flexibility and quicker availability than traditional bank loans.

Again, microfinancing will be an option that buyers need to research thoroughly before committing to, in order to avoid the possibility of getting locked into unfavourable terms with an untrustworthy lender. Finally, as microfinancing consists of small loans of typically less than £50,000, buyers utilising them for M&A will most likely need to use them alongside a more substantial form of financing.

Despite the challenges dealmakers, especially smaller businesses, might face in the current environment, there are still options available for those looking to raise the funds to complete acquisitions. With so many non-traditional avenues for financing, creative buyers with a solid M&A strategy in place should be able to attract the funding they need for their dealmaking plans.