Don’t discount the importance of people when it comes to funding a deal

Peter Bennett, head of technology investment banking at Davy, points out that while 2021 was a huge year for M&A activity, he does not see 2023 breaking that level.

“2021 was an all-high record year in terms of volumes, with about $5.7 trillion (€5.3 trillion) announced globally but that reduced to about a third last year, settling at $3.6 trillion globally. However, 2022 was a very different environment in terms of the geopolitical situation, cost of living and inflation,” says Bennett.

“People have revised downward their risk appetite over the past year, which is reflected in the reduced figures. But as we go into 2023 there is better cause for optimism, as it looks as though the threat of recession is receding somewhat.”

Usually, the main sources for M&A funding fall into two categories: equity and debt. A third could be internal cash resources, if available. Within equity, there are variations, but M&A can generally be funded via support from the acquirer’s existing shareholders or new shareholders. Within debt, again there are many variations, depending on the profile of the acquirer, the target, the pro-forma company, and overall industry and macro conditions. Alternatives generally include bonds, loans and other sources of bank financing.

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Don Harrington leads the growth team at Goodbody Stockbrokers, which advises companies on fundraising and M&A activities in high-growth areas such as technology, telecoms and healthcare.

In terms of looking for the more elusive funding opportunities, Harrington stresses the importance of having the right team in place.

The good news is there are more funding options available than any time in the recent past, ranging from traditional bank funding to alternative debt providers and private equity players

—  Richard Duffy, BDO

“Firstly, you need a team with a proven track record of running their own business successfully,” he says. “If they don’t have direct experience of M&A then we advise them to bring in people who have done this before, either as a non-executive or hands-on CFO.”

Fergal McAleavey, partner and head of corporate finance at EY Ireland, agrees.

“The team is one of the most important aspects of a transaction. Whilst it is likely that additional members will be added to the senior management team to enhance it, the core management team will ultimately be responsible for delivering the business plan set out at completion,” says McAleavey.

Richard Duffy, director at BDO, says that while there are plenty of funders in the market, securing funding is not easy.

“You should seek advice from an experienced adviser at the outset,” Duffy says. “Your adviser should, importantly, be well networked and have access to both debt and equity funding partners, locally and internationally. They should ensure your business plan is as robust as possible before presentation to funders, work with you to establish your funding requirement and assess what type of funding support you need, which best fits your capital structure. In summary, in order to be successful: prepare well, be credible, seek advice.”

As finance for funding M&A usually comes from a combination of debt and equity sources, Duffy suggests that the type of finance is dependent on the life cycle of the development of the business and its capital structure at the time it goes to raise finance.

“The good news is there are more funding options available than any time in the recent past, ranging from traditional bank funding to alternative debt providers and private equity players,” says Duffy. “Availability of capital is no longer an impediment, assuming you have a business plan that is credible, have growth potential and you have capable management who can deliver the plan.”

Duffy advised that a number of factors need to be considered when assessing the optimal funding structure and sources of finance for prospective M&A.

We would also advise building scenario analysis to show potential lenders that you have considered what might happen if revenue fell by, say, 5 per cent or costs went up

—  Don Harrington, Goodbody Stockbrokers

“The first is sustainable level of cashflows in the combined businesses; the second is the upfront costs associated with the integration of the target and timing of potential cost savings,” he says.

“Then companies need to evaluate working capital and capital expenditure requirements, level of security available for funders and, finally, target return on equity if required.”

With increasing interest rates and rising inflation, Duffy says that many companies are looking to lower their leverage ratios, while trade and private equity buyers are seeking to deploy their cash upfront, which will result in lower levels of debt being used in M&A deals.

For firms seeking to acquire larger companies, other factors come into play. Harrington does not dismiss such ambitions but says they raise questions such as, can the acquiring company digest the target business?

“Can the two businesses be integrated? Sometimes it happens that the two entities already know each other and one CEO might want to retire. Either way, the company needs to make sure the acquisition makes sense before seeking funding,” says Harrington.

M&A plans should also include rebuilding financial models for the two businesses, incorporating financial diligence and tax diligence.

“We would also advise building scenario analysis to show potential lenders that you have considered what might happen if revenue fell by, say, 5 per cent or costs went up. How might that flexing of revenue and cost impact your cash flows?” says Harrington.

When it comes to gauging the level of debt, McAleavey advises that calculations are typically set on multiples of EBITDA (earnings before interest, tax, depreciation and amortisation). He says traditional pillar banks will typically lend circa two to three times EBITDA, while there are also alternative lenders who have a greater risk appetite.

His colleague, Ronan Murray, also a partner at EY Ireland, adds: “In terms of other key non-financial considerations, environmental, social and governance (ESG) is very much at the forefront of every funding conversation and has risen to the top tier of investment criteria. It is now deemed essential in terms of protecting long-term value. This has become equally important in the context of debt, as ESG considerations are now intertwined with underwriting principles and credit decisions of lenders.”

Finally, when it comes to choosing between equity and vendor lending, Bennet is prosaic: “It depends on the cost of the debt, of course. In addition, leaning towards equity is usually determined on possible non-financial benefits such as expertise, networks and resources.”