There are three general classes of buyers that might acquire your company: 1) A Strategic Buyer (strategic), 2) a pure Private Equity Group (PEG), 3) a Merchant’s Bank.
The strategic is the easiest to describe. That is the lumber dealer across town or across the state who wants to acquire a competitor. Typically, the owner of Lumber Dealer A will call the owner of Lumber Dealer B and ask if they are interested in talking. If so, Dealer A will make an offer. The structure of strategic acquisitions are typically highly leveraged, since Dealer A wants to risk as little cash as possible. Dealer A’s offer will often be a blend of cash, and these two additional deal elements: 1) Dealer A will pay Dealer B using future proceeds of the acquired company, and 2) Dealer A will want a seller’s note where the acquired company will lend the acquirer funds to buy them. (More on seller notes below.) Dealer A, the acquirer, might even go to the bank to borrow some of the money required on their own.
A pure PEG is a private equity group with ready access to equity funding, often referred to as, “dry powder”. They have gone out to debt markets ahead of your acquisition, and they have senior debt/subordinated debt commitments and cash in-hand (equity) before making an offer. Let’s say that a PEG offers $10 million, all cash, for your company. Even with $10 million on hand, a PEG will go to debt markets and fund around 45% of that $10 million in senior and subordinate debt, while coming up with around 55% of that total on their own with committed equity from their limited partners. The debt payments for the 45% are hung on the NewCo created by the acquisition.
A PEG may also leverage the seller with earn-outs and seller’s notes, but for the cash portion of the deal (even with some of it borrowed) the PEG is very good for the money, and a PEG deal often moves quickly to closing.
A Merchant’s Bank is a PEG hybrid. They acquire companies as a PEG does, but they fund the deals in a different manner. When a Merchant’s Bank makes an offer to acquire a company, it does not necessarily have the money for the acquisition as ready funds, a.k.a. dry powder. A Merchant’s Bank may put in some of their own cash (typically supplied by their members, who are called limited partners), but they typically seek financing on a deal-by-deal basis. Or, even more likely—to get the best bank rates— a Merchant’s Bank will wrap up several acquisitions into one financing bank package. Because of these time-consuming machinations, a Merchant’s Bank deal very often takes longer to get closed than one with a PEG that simply writes a check or has bank credit arranged ahead of time. A Merchant’s Bank may also leverage you with earn-outs and seller’s notes.
Today, seller’s notes in all three types of acquirers are typically 7% interest, for five years, with the balloon to be paid on the fifth anniversary. The reason the interest rate is so attractive is because these notes are largely unsecured, or, if secured, they are third in line behind the bank. If you are resistant to a pure-interest seller’s note (until the balloon is paid), you can, through your investment banker, request a blend of principal and interest, where the principal starts to amortize down starting in, say, the third year of the loan.
In declining order of preference for a type of acquirer, rated on how easily and quickly a deal can get done: Go with a pure PEG if you have a choice. They have the cash portion of the acquisition funds ready. Next choice: a Merchant’s Bank, the drawback being the time it takes to do the deal or combine yours with others in a financing package. Last choice: Strategics often structure highly leveraged deals, but since their acquisition expertise may not be super refined, these deals often take the longest and involve the most seller leverage.
John Wagner is a managing director at 1stWest Mergers & Acquisitions, which offers a specialty practice in the LBM sector. Reach John at email@example.com