The re-emergence of debt in business acquisitions
In the ever-changing landscape of mergers and acquisitions (M&A), debt is re-emerging as a strategic financing tool for those looking to acquire a business. With lender confidence returning, more buyers are reassessing debt options to fund acquisitions.
Below, we explore why debt options are re-emerging, the types of debt financing which are available, and considerations for business owners thinking of using debt to buy a business.
Why are debt options gaining popularity again?
Over the past few years, rising interest rates and economic uncertainty made many business owners wary of taking on debt. However, from what we’ve seen, there has been a change in thinking this year. Stabilising interest rates have made long-term debt more predictable, and banks and other lenders have been more willing to provide tailored lending structures to support deals.
This re-emergence of debt reflects growing market confidence and creates opportunities for business owners to pursue growth through acquisition without relying solely on equity.
What debt options are available for M&A financing?
When buying a business, there are several types of debt financing which are commonly used.
- Senior debt
This is provided by banks or mainstream lenders and is often the first layer of financing in a deal. Senior debt typically has the lowest cost but requires strong financial covenants and security over assets. This type of debt is ideal for stable businesses with a strong cash flow. - Mezzanine finance
This is more flexible than senior debt but comes with a higher interest rate, often with equity-like features such as warrants. Businesses looking to limit equity dilution while accessing more capital would be best for this type of debt. - Asset-based lending (ABL)
This type of debt is secured against the target’s assets - like inventory, receivables, or property - but can also be secured against the acquiring business’ own assets. That makes it ideal for asset-rich businesses or acquisitions where working capital is a key driver. - Vendor or seller finance
This is increasingly common in small and medium enterprise (SME) transactions and allows part of the purchase price to be deferred and repaid over time to the seller. A debt option like this is perfect for deals where sellers want to support a smooth transition and buyers need flexible repayment options.
When should you consider debt to fund an acquisition?
Debt can be an effective financing tool if:
- Preserving equity or avoiding shareholder dilution is important.
- The business you are buying has predictable cash flows to make repayments.
- Raising equity would take too long and the deal needs to progress quickly.
Using debt requires a clear understanding of repayment obligations and how the acquisition will perform post-deal. For an in-depth guide to managing acquisition stages, see our article on the five stages of an M&A transaction.
What are the risks of using debt financing?
While debt can enhance returns, it also increases financial risk due to possible:
- Pressure on cash flow pressure caused by debt repayment schedules.
- Contractual covenants that could limit how you run the business.
- Financial distress if the acquisition underperforms.
Due to the associated risks, it's important that any decision to utilise this strategy is carefully assessed and managed. A specialist adviser should also be engaged to help you find the most suitable funding option for your particular set of circumstances, and negotiate the best terms possible with lenders.
Disadvantages of debt financing
- Repayment obligations
Debt must be repaid regardless of business performance, which can strain cash flow during slow sales or difficult periods. - Interest costs
Most loans involve paying interest, adding to the total financing cost. Interest rates may also vary based on market conditions, affecting repayment amounts. - Credit risk
Difficulty in repaying debt can harm your business’ credit rating, making future borrowing more costly and harder to secure. - Collateral requirements
Lenders often require collateral, particularly for newer businesses. This means personal or business assets could be at risk if the loan is not repaid, as lenders have the right to seize these assets.
Advantages of debt financing
- Retain full control
Using debt financing lets you maintain complete ownership of your business, so you can access funds without giving up any equity or control. - Tax benefits
Interest payments on loans are typically tax-deductible, which can lower your overall tax liability and improve cash flow. - Predictable repayments
Debt financing usually comes with a fixed repayment schedule, helping you plan your finances and manage cash flow more effectively. - Improve credit rating
Timely repayment of debt can enhance your business credit score, making it easier and more affordable to obtain financing in the future.
We’re here to help
If you're considering using debt to fund a business purchase or would like to discuss debt options that are available to you, please get in touch with a member of our specialist team using the form below.
