MarktoMarket recently hosted a roundtable breakfast event with Altenburg Advisory to discuss debt funding strategies for M&A transactions, examining essential considerations, market appetite, and emerging trends.

Summary

Businesses with strong credit fundamentals have a breadth and depth of funding options while weaker businesses have fewer choices. Credit funds are emerging as more flexible alternatives to traditional banks, particularly for sectors with less ‘vanilla’ characteristics. Key success factors in attracting debt funding for M&A strategies include demonstrating robust integration teams and processes, justifying credible valuations and ensuring heads of terms agreed with vendors consider the debt funders’ perspective.

Current Lending Landscape
Businesses with stronger credit characteristics, such as sustainable revenue growth, strong profitability and cash conversion, and operations in resilient market are likely to find more funding options than those with weaker credit characteristics.

Following the turbulence of recent years (Covid, inflation, the tariffs, global uncertainty, etc.) businesses are tending to find that lenders are taking a binary approach to assessing them as potential borrowers – they like either the business or the sector, or they don’t.

Alternative lenders and credit funds are willing to consider more complex situations and structure creative solutions.

The tech sector exemplifies current market pressures. Private equity and trade buyers who acquired at elevated Covid-era valuations now face exit and refinancing challenges as multiples have softened.
Altenburg emphasised that roll-up strategies can no longer rely on multiple arbitrage alone – genuine value creation strategies are essential for both the equity and debt case

High street banks find it more difficult to adjust pricing to reflect risk, i.e. a business either fits the credit framework or it doesn’t, and they remain wary of unproven business models and technology. Credit funds can demonstrate greater flexibility, with a willingness to embrace a level of uncertainty, reflected in pricing. As a broad brush point the different approaches of these lending groups extends to credit failure.  When loans fail, credit funds are often more likely to take a more patient view or to assume operational control to execute turnarounds, whereas high street banks are potentially more likely to appoint administrators earlier.

A common pathway for borrowers in today’s environment involves securing initial funding from challenger banks or direct lenders, then refinancing into cheaper high street options once growth materialises and the business has de-risked.

Looking ahead, Altenburg suggests that some retail banks may exit most, or even all, business lending within 10-15 years, and focus on day-to-day and ancillary banking with lending provided by credit funds.

What Lenders Assess

Sector and quality. Attractive businesses command competitive interest regardless of industry. Lender confidence drives flexibility.

Customer concentration. Concentration is less of a risk when a borrower can demonstrate a long track record with a dominant customers, established (potentially symbiotic) relationship, and high barriers to replacement.

Scale and track record. For businesses below £1m EBITDA the frictional costs of securing the lending (due diligence, legal fees etc) can be high relative to the sum borrowed making it more difficult or at least expensive for acquirers. Additionally, some lenders struggle to achieve their target returns on smaller deals, reducing the potential options for smaller businesses

Search funds: Search funds are gaining more and more acceptance especially when backed-up with credible operational experience and/or a strong equity stack.

Integration and cap table. Lenders scrutinise integration processes for borrowers with M&A strategies, speaking with existing investors, and gaining comfort from continued equity support.

Cost of funding: cost should almost be viewed as the output (rather than the starting point) and as a function of the credit risk and flexibility of the solution provided.

Conclusion

The lending market remains dynamic, with terms changing as lenders evolve through their own business lifecycles. To secure optimal funding for acquisition capital, businesses must demonstrate robust integration processes, present credible valuations, and translate their equity story into compelling funding cases. Most critically, they should considering getting advice  before agreeing Heads of Terms to reduce the risk of needing to retrofit debt solutions to pre agreed equity terms. Institutional backing can strengthen a business’ positioning significantly. In today’s market, thorough preparation and, where appropriate, professional guidance separate successful debt raises from those that miss the opportunity.

Visit the MarktoMarket website: https://marktomarket.io/

Visit the Altenburg Advisory website: https://www.altenburgadvisory.com/