In the world of mergers and acquisitions (M&A), banks have traditionally often still been the main source of acquisition financing. However, with rising interest rates and market turmoil, banks have become more cautious and have been lending less money for mergers and acquisitions, among other things, in recent years.
This creates challenges for buying businesses seeking (partial) financing for acquisition transactions. Consequently, there is increasing scope for alternative sources of financing.
Below we briefly discuss a number of alternative sources of financing to the bank. The following parties will be discussed: private equity firms, angel investors and crowdfunding platforms.
Pros and cons
One advantage of these parties over traditional bank financing is their flexibility. Unlike banks, which often have strict requirements and lending criteria, these parties can offer more creative and flexible financing options. Because of their background, often co-funded by (former) entrepreneurs, they are also willing to invest in riskier companies or provide financing for acquisitions with more unconventional structures.
Another advantage of these alternative investment sources is their ability to act quickly. Banks typically have a lengthy approval process, partly due to the present-day Know Your Customer (KYC) process. For example, it can even take several months to finally get a bank loan approved. In contrast to this lengthy process, alternative investors can sometimes provide approval in terms of financing within just a few weeks, which can be crucial in a competitive M&A landscape.
Of course, there are also potential drawbacks to working with these types of parties. For example, they often demand control and the returns demanded with these types of parties tend to be significantly higher. One way to achieve these higher returns is to improve businesses and eventually sell them again. Thus, the goals and priorities of the entrepreneur seeking financing may be different, which can lead to conflicts in the long run.
Private equity
Private equity firms typically obtain capital from institutional investors and high net worth individuals and use this capital to buy and manage businesses. Despite the potential drawbacks, many entrepreneurs are increasingly turning to private equity firms to work with them to realize their buying ambitions.
According to a report by EY, private equity firms have become an increasingly important party in acquisition financing in recent years. They now represent about 30% of M&A deals, passing the peak of 25% from 2006.
Another important issue is understanding the exit strategy of these investors. Private equity firms, due to their formal fund structure, are usually looking for a good return on their investment within a time horizon between 3 to 7 years. This means that they are actively looking for an exit opportunity within this period.
Entrepreneurs who team up with a private equity party to develop a growth strategy should be aware of this and ensure that the ambitions remain aligned.
Angel investors
Another alternative source of investment to the bank are angel investors. These are often private individuals or groups of (former) entrepreneurs who provide capital in a less formal way to startups or early-stage businesses, for example, in exchange for an equity stake in the company.
They can also offer flexible financing options to businesses seeking capital for M&A deals, and can offer valuable advice and guidance with their experience. Again, entrepreneurs should keep in mind the aforementioned disadvantages such as sharing control, among others.
Crowdfunding
Crowdfunding is also an alternative form of bank financing for small and medium-sized businesses, where a large group (the crowd) collectively invests in a company. Entrepreneurs can raise money this way through an online platform where many people invest a (small) amount.
One advantage of crowdfunding is that it is a relatively easy way to receive financing for a project or venture. The assessment of whether or not to provide financing is more focused on the quality of the business. In addition to funding, a crowdfunding platform can help raise brand awareness as well as further growth of the business.
On the other hand, crowdfunding also comes with some drawbacks. For example, it can be difficult to raise enough financing to make the project or business successful. It can also lead to high costs, as crowdfunding platforms often charge commissions for their services and, on the other hand, demand relatively high interest rates.
Careful selection
So, there are certainly in these uncertain times alternatives to the bank as a financier in acquisition projects. However, it is very important to know what kind of party you are going to do business with. After all, you are going to share some of the control and therefore you need to carefully select a potential investor/financier. This includes researching their track record, understanding their investment philosophy and goals, and making sure their interests match those of the entrepreneur and the company.
