Choosing the right funding structure is as crucial as choosing the right target
Deploying balance sheeet cash is often the simplest and most certain option to fund an acquisition. Picture: iStock.
Buying other companies instead of building new operations from scratch is a tried and trusted way for businesses to expand size, revenue and market share. How you fund it is critical.
“Acquisitions can support growth more quickly than building new operations from the ground up but choosing the right funding structure is just as important as choosing the right target,” says Colm Sheehan, partner in the corporate finance department at accounting firm Crowe.
The first consideration is whether the acquiring business has the resources available. “Many companies fund acquisitions using surplus cash on the balance sheet where they have strong cash reserves and wish to avoid taking on additional debt. It is important to consider the opportunity cost of using this available cash – could the cash be deployed elsewhere to deliver a return that is greater than the funding cost of financing an acquisition through debt?” he asks.
Traditional bank lending remains one of the most common funding sources, especially for established companies with predictable cash flows, but the alternative lending market has grown in recent years.
“Although a more expensive form of debt compared to bank lending, it can be more flexible in terms of repayment structures – which may be useful for companies who wish to conserve cash reserves in the short-term,” says Sheehan.
Established companies may also use their own shares as acquisition currency, either as part of the consideration or to fund the transaction entirely. “This can be attractive where both parties wish to share in the future growth of the combined business. Effectively a seller part-reinvests their proceeds from sale for shares in the buyer’s company or group, with a view to participating in the future growth of the enlarged business,” he explains.
Private equity can also play an important role. “A private equity investor can provide growth capital that enables a business to pursue accelerated growth or larger or more ambitious acquisitions than might otherwise be possible,” he says.
In practice, transactions are often funded through a combination of sources, each of which has pros and cons.
“Cash from the balance sheet offers speed and certainty, but depletes reserves needed for operational resilience. Debt preserves equity and is tax-efficient through interest deductibility yet introduces repayment obligations and covenants that constrain flexibility. Growth equity brings capital plus strategic expertise without repayment pressure, though it dilutes ownership,” explains Laura Gilbride, partner, deals at PwC Ireland.
“The optimal structure blends these, funding growth while retaining as much equity as possible.” Whatever mechanism you choose, the greatest cost is distraction. “Acquisitions consume management bandwidth, risking an ‘eye off the ball’ if processes drag. A clear, predefined acquisition framework keeps you proactive rather than reactive, and capability-driven deals create more shareholder value than defensive ones,” explains Gilbride.
“PwC’s Creating Value Beyond the Deal research consistently shows integration and people, not price, drive returns.” There is a wide range of capital available. “From an equity perspective, the vast amount of capital available to deploy has created strong competition for good deals,” says David O’Kelly, partner and head of M&A at KPMG.
“Equity providers are also seeking to differentiate themselves with alternative structures that suit the needs of founders. Examples of this flexibility can be seen in some of the recent minority equity deals.” The number of banks based in the Irish market has, however, decreased significantly over the past decade. “This reduction in competition has impacted the domestic options available to borrowers. Working with clients, we seek alternatives from overseas funds and international banks to ensure they can optimise their structures,” says O’Kelly.
There is no universally optimal source of funding. “The right answer depends on the acquirer’s strategic objectives, balance sheet strength, cost of capital, appetite for risk and the expected returns from the transaction. The key objective should be to maximise long-term shareholder value rather than simply minimise funding costs,” says Stephen Kane, head of corporate advisory at Goodbody.
Deploying balance sheet cash is often the simplest and most certain funding option. “It avoids financing execution risk, preserves ownership control and allows management to move quickly in competitive processes. It can also be attractive where the expected acquisition return materially exceeds the return available from holding excess cash.” However, cash is a strategic asset. “Every euro invested in an acquisition is a euro that cannot be deployed elsewhere. Buyers must consider the opportunity cost of the investment alongside maintaining sufficient liquidity to navigate periods of uncertainty and fund future growth opportunities,” says Kane.
Debt can be a highly efficient acquisition funding tool. “Borrowing can be particularly attractive where the target generates predictable cash flows capable of supporting the additional leverage. However, leverage amplifies both upside and downside outcomes. Excessive borrowing can restrict strategic flexibility, increase refinancing risk and limit a company’s ability to respond to changing market conditions or pursue future investment opportunities.” Other options include vendor financing. “It demonstrates the seller’s confidence in the business, reduces immediate funding requirements and can improve overall transaction economics. However, it creates future payment obligations and introduces ongoing counterparty exposure between buyer and seller,” Kane points out.
Earn-outs can be a powerful tool for aligning incentives and bridging valuation gaps. “They transfer a portion of the performance risk back to the seller and can reduce the amount of upfront capital required. However, poorly designed earn-outs can create disputes and misalignment around business strategy after completion.”.
Third-party equity capital provides additional acquisition firepower without increasing leverage. “This can be attractive for transformational acquisitions or businesses pursuing an ambitious buy-and-build strategy. The trade-off is dilution, together with increased governance requirements and investor involvement in strategic decision-making.” Before going on the acquisition trail, a buyer needs to be clear on its acquisition strategy and how that fits in with the company’s overall strategy. “Acquisitions should be an extension of strategy, not a substitute for one. The most successful acquirers have a clearly defined investment thesis, disciplined acquisition criteria and a strong understanding of how each transaction contributes to long-term value creation,” says Kane.
“Great acquirers pursue transactions that strengthen competitive advantage, accelerate growth, improve market positioning or create operational synergies. Poor acquisitions are often driven by deal momentum, competitive pressure or a belief that scale alone creates value.” The focus should not simply be on how to complete the transaction. “The more important question is whether the business will have sufficient liquidity and working capital to support integration and growth afterwards,” says Ala Browne, Bibby Financial Services’ sales lead.
Bibby supports acquisition, MBO and ownership-transition activity through invoice finance, working capital and asset-based funding solutions.
“Increasingly, transactions are being supported by blended funding structures combining traditional debt, equity, asset-based lending and invoice finance rather than relying on a single source of capital. This can create greater flexibility, reduce pressure on cash flow and ensure the funding structure reflects both the immediate transaction and the longer-term needs of the business,” says Browne.
According to Bibby Financial Services’ recent SME Confidence Tracker, more than a third (34 per cent) of Irish businesses plan to explore a merger or acquisition transaction this year, with an additional 14 per cent considering a full sale.
For many such businesses, additional funding capacity already exists within the balance sheet. “A strong sales ledger can support an invoice finance facility, enabling the business to leverage eligible trade receivables as part of the wider funding package,” says Browne.
“This can reduce reliance on additional acquisition debt while preserving liquidity to trade, invest and pursue the opportunities the acquisition was intended to create.”
