Just like the title says I am interested in learning more about how PE backed companies finance add-on acquisitions. Generally when these companies are already levered up, they need to use excess cash to pay down debt. Is the company able to use the additional excess cash to fund the acquisition or does the PE fund use its own capital to fund the acquisition then bolt on to its portfolio company.
Any insight is appreciated. Thanks!
there is no general rule on this, if they need to do few add-ons to boost business, they will try to raise debt if possible, otherwise, they will use own money to invest to finance the add-on acquisitions since they believe it will increase exit value for them
We would generally set aside a portion of committed capital for add-ons. For example, if an investment took $200mm of equity, we would commit $250mm total, allowing for $50mm of add-ons. This is speaking off the experience I had with the PE shop I was at this past summer, of course.
This is how my firm does it as well
Are you saying for roll-ups?
In practice, the sponsor will set aside a portion of incremental equity to fund acquisitions, which the acquiror can use. However, when it comes time to actually add these on (in like year 2 or 3 or whatever), the acquiror can usually draw on their revolver, which is usually unfunded at the date the acquiror is taken private by the sponsor.
Understood. That helped a lot. The portfolio company makes a lot acquisitions so the revolver makes sense to help fund those.
Thanks guys this info helped
Coming from a Sponsor/LevFin group, there are a few ways you see them fund add-ons:
Incremental Debt: Credit agreements build in incremental debt options that allow for new debt raises as long as the post-close leverage meets a certain threshold. Lets say the platform company is leveraged 3x and the CA allows for pro forma post-close leverage of 4x. If the platform company was $10MM in EBITDA (pre-acquisition debt of $30MM), an add-on of $2MM in EBITDA could use up to $18MM (9x purchase price) in debt (typically subject to dollar limit thresholds) and be in compliance of the 4x threshold ($48MM total debt / $12MM Combined EBITDA). Note that the company could not make any more acquisitions using debt until debt is paid down or organic EBITDA significantly improves.
Equity Infusion: The sponsor contributes an additional $18MM to the platform to purchase the target (usually completed at the same time the acquisition occurs). Leverage actually comes down in this scenario, given the higher EBITDA and unchanged debt level ($30MM total debt / $12MM EBITDA).
Combined Equity/Debt: The Sponsor may provide part of the equity and raise part of the debt. Using the above example, lets say the sponsor puts in 50% ($9MM) and raises 50% debt ($9MM). The platform would have post-close pro forma leverage of 3.25x ($39MM total debt / $12MM EBITDA). The Company would still have some "dry powder" to make future acquisitions using debt.
A revolver could be used for smaller acquisitions, but incremental term debt is more typical.
Thank you! this is good information
Bang on.
Generally speaking, the objective of a PE firm is to minimize additional equity contributions when it comes to bolt-ons so you'll see the financing of bolt-on deals reflecting this.
In addition, additional capital calls from LPs may be structured like mezz debt, especially if the GP sees the debt getting refinanced by 3rd party debt in the future.
Agreed with this. I will add that when we have a buy and build and we know we'll need equity later on, we don't invest that growth capital at close. We wait until it's actually needed because why would the founder(s) dilute themselves if they never end up needing the cash.
The most common practice is to use as much debt as possible to fund acquisitions. The credit indentures have all kinds of leeway to allow it and generally if the target is PF EBITDA positive and is being bought for a lesser EV multiple than what the platform company's pre-acquisition leverage level is, creditors will (blindly and foolishly) think the acquisition is leverage Accretive and will opt to fund it. If you're the sponsor you want to use as much debt as possible. Every dollar of debt you borrow to expand the enterprise value will be Accretive to equity returns.
great, thanks!
Agree with the comments above but just adding a few more details here.
The credit agreement lays out the nuances of the permitted acquisition provision under the negative covenants. It obviously varies case by case but generally speaking it caps whether the portfolio company can make bolt-on acquisitions on an absolute dollar basis or pro forma leverage basis.
true, but the permitted acquisition provision is more important in that it caps the amount of acquisitions in aggregate (and often in calendar years) for acquisitions where they do not need to get approval from the lenders. in almost all instances if it is an Accretive/logical acquisition they can get a waiver from their lenders very quickly. it does not really have to do with how they actually fund acquisitions.
LeverageThis hit the primary methods over the head, but to also discuss another permutation, there is another type of credit facility called a Delayed Draw facility, which unlike Incremental Debt is committed financing that is common in LBO or acquisition financing and is often tied to specific uses of capital such as acquisitions. While this approach is more expensive to the borrower, as they have to pay an undrawn or "ticking" fee in a rate equivalent to either the full spread or some percentage of the spread when its not used, they have the benefit of speed. This contrasts with Incremental Debt that might be built into the credit agreement, but is not committed and the borrower, or it's agent banks, need to arrange that financing. A delayed draw facility offers faster execution for companies that are planning to be acquisitive.
A few other methods for financing a portion of small add-ons that don't require cash up front are earnouts and seller debt. Earnouts are payments to the sellers that are contingent on some milestone that the acquired business has to meet, and the payment can generally be made from the cash flows of the business and seller debt is a portion of the purchase agreement which is structured as debt, but often is unsecured or subordinated to any existing senior debt and payments are made out of the company's cash flows over time.
Preferred equity... it's a bitch
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