A Guide to Acquisition Finance

What is Acquisition Finance?

Acquisition finance is the capital that is obtained for the purpose of buying another business. 

Obtaining acquisition finance is a vital part of the natural cycle of many businesses. It is often necessary to require acquisition finance when a dental practice has successfully started up and grown its client base to a point when it is then time to grow the business by purchasing another practice. It then needs to raise funds in order to complete the transaction. 

By acquiring another company, a smaller company can increase the size of its operations and benefit from the economies achieved through the purchase. An acquisition can help your dental practice in many ways. For example, it can help your dental practice: move into a new market segment, increase the client base, expand, gather knowledge, and improve their output. However, these opportunities often come with big expenses. Bank loans, lines of credit and loans from private lenders are all common choices for acquisition finance. Other types of acquisition finance also include start up loans (government funded), debt security and owner financing.

The business market is always changing and has gone through many significant changes over the last decade however, the biggest changes within the dental industry have occurred within the last year due to the pandemic. There are now various new lenders available for acquisition finance, new deal structures and new lending criteria. 

How to raise acquisition finance

There are many ways to finance dental practice purchases. Most purchase transactions are structured using some of these methods. It is perfectly viable to only use only one method if that is sufficient enough for you however, in many cases, some of these options are used in conjunction to finance a business acquisition. The methods you chose will be the ones that best suit your needs and business transaction.

1. Using your own funds
   
   To use your own cash reserve is one of the simplest ways to finance a business acquisition. These funds can come from your savings, estate income or home equity.
   
   Although using your own funds is a very effective debt free way to complete the purchase, it is uncommon for an individual to acquire a business using their funds alone for the purchase. Instead most buyers use their personal funds in combination with business loans or with seller financing. The large personal funds of an individual or company can work as leverage to them allowing them to purchase larger, more established dental practices.
   
2. Government loan
   
   Another option to source acquisition finance is to get a loan or grant that is certified from the UK government, available dental practices as well as many other businesses and industries. These loans are often referred to as start up loans with the intent to help your dental businesses grow. Unlike a business loan, this loan is an unsecured personal loan. They are government backed loans and charge a fixed rate of 6% per year. The term to repay the loan can range over a period of 1 to 5 years. The advantage of this type of loan is that there are no application fees and no early repayment fees either.
   
3. Bank loan
   
   Getting a conventional loan such as a term loan from a commercial bank to raise acquisition finance can often seem like the easiest option to fund your practice purchase, but it can be very difficult. Usually, as a rule, banks lend funds against existing assets rather than against business plans. Therefore, to get a loan from a bank, you usually must have substantial assets and a good credit history at the least. For most conventional borrowers, the best option available to allow them to get the funds they need is to get a bank loan guaranteed by their existing assets.
   
4. Leveraged buyout (LBO)
   
   A very common financing structure to buy a smaller dental practice is a leveraged buyout. Leverage buyouts are the acquisition of another company using a significant amount of borrowed money in order to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans, along with the assets of the acquiring company. In a leveraged buyout (LBO), there is usually a ratio of 90% debt to 10% equity.
   
5. Seller financing
   
   Another common way to source acquisition finance is to ask the seller themselves to provide financing. In this case, the seller provides you with a loan that is amortised over a period of time. The proceeds that you retain from the business will be the funds that allow you to pay back the loan. Business buyers like seller financing because it is a lot easier to obtain than conventional financing, with the bonus benefit that it can also be cheaper.
   
   On average, sellers are usually willing to finance 30% to 60% of the agreed upon sale price. There are very few sellers that will finance more than that. However, it is highly dependent on what type of buyer you are. If you are a strong buyer with substantial assets as well as a large down payment, then there is a chance that there will be a seller that will be willing to finance a higher percentage.
   
   Like any other type of finance, the seller will only provide financing for you after they have done their due diligence on you. Your credentials such as your credit, assets, business plan and experience will all be assessed before you will be provided any funding. Experience within the dental industry itself is vital, having experience being a dental practice owner will work very well in your favour.
   
6. Assumption of debt
   
   There are two common ways to acquire a business. You can either purchase the assets or the stock. Buying the assets ensures that you the only thing you are purchasing are the assets themselves without any of the ‘bad liabilities’ for example, future lawsuits. However, if you buy the stock, you get all the assets of the company, its liabilities as well as all the risks involved. 
   
   Most asset purchases involve the transfer of some assets and liabilities. This point is important because part of your payment to the seller may be the assumption of existing business debt. This process can sometimes get complicated, as you often need the approval of the debtors before assuming the debt. 

What is a “No-Money-Down” Opportunity?

There are often entrepreneurs who look to acquire businesses for “no money down.” This means that these entrepreneurs are hoping to get 100% external lender or seller financing. To clarify, for all intents and purposes, these transactions do not exist.

From a seller or lender perspective, they would need a pretty big incentive to be giving someone 100% financing.

While some transactions could meet this criteria, the odds are as likely as winning the lottery. In other words, “possible, but not probable.” It’s best to prepare yourself to put a substantial amount of money down.

Acquisition Finance and Closing Costs 

It is important to remember that getting financing for your dental practice usually increases your closing costs. These closing costs will include your contribution to the purchase of the business and will directly come from you, the buyer. The size and type of business you are looking to acquire is heavily dependent on the amount you need to budget for closing costs. The costs vary but as a rule it is best to budget at least 10% of the purchase price for closing costs however, if you are able to allow for 20%, that would put you in a much better position. 

What is a management buy-in (MBI)?

A management buy-in (MBI) is the acquisition of a business by a management team or individuals external from the current company on sale.  

MBIs usually require external funding from banks, private lenders or private equity investors. After these investors contribute to the acquisition of the company, they will be entitled to a share of the profits if the company becomes profitable. 

A management buy-in team often competes with other purchasers to buy the company. The competitors often vary but it is usually in the best interest of the company to allow an internal acquisition (MBO) rather than external (MBI) to take place.

After the acquisition goes through, the buying managers may replace the current board of directors with their own representatives. An MBI can vary from 100% acquisition of a business to a majority controlling stake in the company. 

The process of MBI

The first step that will need to be taken is that an external team will need to gather all the necessary information about the company it intends to purchase. This includes an in depth market analysis of the company as well as its buyers, products, suppliers, sellers and its competitors.  

An important part of this step is to find out about any other competing buyers who are interested in purchasing the target company; many dental practices for sale often have a lot of competitive buyers. Once this step is completed, the external management will begin negotiating appropriate selling prices with the vendors. 

Advantages of Management Buy-Ins

In the case that the current owners and management team of the practice in question are not able to effectively manage the company, then an MBI can be a convenient win-win situation for both buying and selling parties. The new management will be able to offer new insights into growing your practice further and may also have better knowledge and experience which they can use to revitalise the company. 

Having experience and knowledge of the sector of the company you are looking to acquire will benefit you immensely, this is why many associate or principle dentists succeed exponentially when they move on to being practice owners. This knowledge will enable you stand out and make you appear to be a great candidate amongst competitors if you have that experience and knowledge behind you.

New management will bring new contacts and opportunities for a company, often bringing in new management and ideas to a dental practice will help revive it and bring new clientele. 

A new management regimen may also motivate current employees as well as bring in ‘new blood’ especially within heath care practices. The change of management could change the entire company morale and client/ patient experiences, particularly if the company is performing poorly.

Disadvantages of Management Buy-Ins 

The reason that an MBI is needed is usually because management lacks the financial power to buy a business outright, which is very common. This usually means that if management do decide to buy, then they might require additional financial help. This typically comes from a bank or private equity fund, which then introduces additional debt to the company and spreads equity thinner amongst investors. 

Debt repayments can reduce profits significantly, they also reduce the money available to pay dividends to shareholders. 

Many investors tend to want to exercise some level of control over the company. In turn, this results in management having to give up some control over the company for investors to be able to have their say. 

Although having new management can help change things in a company for the better, it can sometimes also have the adverse effects. The new management may fail to bring the necessary growth of the company that was expected by their arrival.

As new management comes in, a management style change is inevitable. In some cases, existing employees do not appreciate the change. It could decrease morale and make them feel demotivated creating further problems down the line. 

Business Acquisitions Often Use Multiple Sources of Funding

It is common to use more than one source of acquisition finance to purchase a business, a lot of the time it is necessary. In addition to the funding needed to acquire the company, partners may want to include a line of credit or a factoring line to handle cash flow after the sale closes. There are other ways that you can potentially structure the transaction depending on the nature of the business and its assets. 

Funding a Management Buy-In 

Most MBIs are financed through a combination of debt and equity. There are other sources such as deferred loans that could also be used. 

Equity will typically comprise ordinary shares and redeemable preference shares. The investors and management of a company will usually subscribe to shares in the holding company in a typical private equity transaction and its subsidiary will act as the bank debt.

The cost of a complete management buy-in is comparable to what it would cost to buy the entire company. It is very rare that a management team will have the funds without needing external funding to aid them in buying a company. 

Acquiring such businesses does produce high costs, however it may be assuring to know that lenders may be sympathetic to new owners. You should aim to invest in a dental practice that is already performing successfully as you can avoid the costs and risks of setting up a new venture in its entirety. By taking over a practice that is already operating successfully, you can avoid the liabilities and costs that may come when taking over a business.

There are a few ways to deal with these costs after a price has been agreed. Usually to fund the transaction, it requires a combination of debt and equity derived from either the buyers, seller or financiers and can be agreed in numerous ways. Many of these funding sources can also be used in conjunction with one another.

Buyer contribution

These are funds that come from the management team themselves. Usually they are required to put up their own personal funds initially to prove their commitment to the transaction. The buyer’s contribution can be raised by selling assets or gaining a second mortgage on an estate that they own.

Asset Refinance

Putting up the assets of the company such as premises and stock or dental equipment (x-ray machines) can generate a high level of funding. Using the leverage of these assets of the company to buy the company itself can prove to be particularly effective especially to businesses with large investments in property. A re-mortgage on a commercial property can raise considerable finance for a business and an additional benefit is that the costs can be spread over 20 years.

Vendor Loan

The vendor themselves can help provide acquisition finance to fund the transition if they choose to donate a sum of their equity as a loan to the company, this will eventually be repaid to them at a future time.

Private equity

Although private equity firms may be able to advance acquisition finance for an MBI transaction, they may also be at liberty to impose strict terms and conditions attached to their financing. These could involve them controlling how certain parts of the practice should be run.

Business Loans:

There are business lenders who may be able to offer acquisition finance as unsecured loans that are repayable over the course of three to five years. A larger amount of money would then be transformed into a secured loan which necessary security of assets from the business would be to be added. 

MBIs and private equity 

A vast majority of buyouts are financed by private equity. MBIs will almost certainly involve private equity. MBIs usually always involve a private equity backing because they represent a higher risk to an investor than a MBO. 

It is common for a private equity loan to involve a loan component as well. Private equity funds invest money in an MBI in return for a proportion of the shares in the company. 

It is important that management teams are aware that private equity funds may have different goals. Private equity backers have the sole intention to make a return on their investment, usually in three to five years. This contrasts to management, they tend to hold a longer term view as this could potentially be their entire career.

Private equity backers like many others, will also want to conduct extensive due diligence before making an investment. 

What is BIMBO?

A BIMBO is a buy-in management buyout, It is a form of leveraged buyout (LBO) where both incoming and existing management are involved in acquiring a company. The existing management represents the buyout portion while the new management represents the buy-in portion. 

What are the disadvantages of BIMBO?

In order for BIMBO to work, new and existing managers must be able to get along. It is natural for new managers to have new ideas and plans that they wish to implement right away while existing managers will try to maintain their business like they always have. These differences between managers can often cause a lot of friction. This can often result in many complications. Pronounced conflicts between managements will distract from the core business and will result in inhibiting profits.

The disadvantage of BIMBOs is that they usually involve an increase of debt of a company. Management needs to ensure that after the acquisition of the company, the fundamentals of the business are adequate enough to service the debt acquired and not cause any further financial stress for the company. 

What is a Management Buy-Out (MBO)?

A management buy-out (MBO) occurs when the management team of a dental practice collectively uses their own assets to buy all or a significant amount of shares in the company they work for. The buy-out is usually achieved through each member’s own funds, however it is common for individuals to require external financial aid from banks or private investors. This could further entitle external parties to a share in the companies profits, should the company make any gain.

Why do MBOs happen?

Often MBOs occur when a shareholder is about to retire or give up/ sell their shares. This gives the management team the perfect opportunity to become shareholders within the same company. 

MBOs are usually a quicker and more efficient option for maintaining a business than to sell the business to a third party. It is also in the best interest of the business itself as the management team already knows the business well, this ensures that they will be able to take over the dental practice completely and continue its growth.

Having an existing management take over requires less time to conduct due diligence, and it presents a relatively low risk path to owning the said business. The current management understands what the company needs to be successful going forward. 

Advantages of MBOs 

The process of an MBO offers advantages to all parties involved. In particular, it allows for a smooth transition of ownership with little impact on the continuity of the business itself; the dental practice can resume its business continuously as normal. 

The management knows the company already, this reduces the risk of failure or unanticipated problems that an MBI acquisition would usually have. 

Current employees are less likely to have a problem with the acquisition change of the company as the status quo is likely to be maintained during the takeover. 

If the company was to be sold through a third party, management may not wish to continue with the business therefore an MBO might prove to be the only mutually acceptable sale route that would benefit the company. 

Disadvantages of MBOs

Management usually lacks the financial power to buy the company outright. This means that a third party seller may be harder to attract. If management decides to buy in then they usually require additional financial funding from banks or private equity funds. This extra funding is typically needed in MBO acquisitions. 

Although it is needed, the extra funding needed for MBOs introduces debt to the business and spreads equity a lot thinner amongst investors. 

Debt repayment affects the books significantly! The repayments may also hinder the company’s ability to pay dividends to shareholders. 

The more equity is spread, the more likely it is that investors want a more controlling say in the company, resulting in management depleting their control in the company in the future. 

MBOs need a lot of working capital to allow the company to be successful in the future. For an MBO to be sustained, the company will need strong fundamentals. This means that the practice itself will need to generate adequate profits on a day to day basis to sustain itself as it develops and provides adequate return for stakeholders, as well as being able to support ongoing capital expenditures. 

What are the differences between MBO and MBI 

The main difference between a buy-out and a buy-in is that the management is external to the company. Simply, this just means that during an MBI, there will be a lot more due diligence required than an MBO. 

Usually, it is thought that the management that is internal to the company will be advantageous as these employees are already experienced and well versed in the company’s affairs. While a management taking over that is external to the company, will usually not be as informed as an MBO offer would be.

Although there are character differences between MBOs and MBIs, the legal structure between the two types of acquisition are usually very similar. 

Finance operations 

Unfortunately, obtaining acquisition finance to buy the business is just the beginning. You will still need to ensure that you have enough funds to effectively operate the business successfully once you acquire it. It is common that people will need additional operational funding however, it can be very difficult to try to get funding immediately after purchasing the business. To ensure you have the funding that you need, it is best to negotiate it while you are negotiating the purchase. 

This section discusses common ways to finance operations.

Line of Credit

An effective way to access acquisition finance is by using a business line of credit. This revolving facility allows you to borrow the money as and when you need it and it can be paid down as your cash flow improves. Although qualifying for line of credit can be very challenging, it is one of the most flexible ways to finance the operations of a business. 

Self-Funding

One of the easiest ways to finance operations is to use your own cash reserve. This reserve can initially fund your acquisition however, it should eventually be financed by the cash flow of the business. Rather than paying suppliers and shareholders immediately, you can also improve your cash reserve by paying your suppliers on net-30 or net-60 day terms.

Invoice Factoring

Lastly, one of the more common reasons businesses experience cash flow problems is due to their cash reserves running low. This problem is common for companies that sell to commercial clients. This setback can seriously impact operations.

The solution to improve your cash flow is by using invoice factoring. It is easier to get than other types of funding and can work well with corporate acquisitions. This solution finances your slow-paying invoices as well as improving the overall cash flow of your business.

What is a leveraged buy-out?

A leveraged buyout, commonly referred to as an LBO, is a type of transaction that companies use to acquire other businesses. Through LBO the business is purchased with a combination of equity and debt. The company’s cash flow is the collateral used to secure and repay the borrowed money. Essentially the buyout is funded with debt. 

The deal is structured so that the target company’s assets and cash flows are used to pay for most of the acquisition finance cost. The purpose of an LBO is to allow a company to make the acquisition they want without having to commit a lot of capital to it. 

Advantages of a Leveraged Buyout

The main advantage of a leveraged buyout is that the buyer gets to spend less of their own money.

An LBO can also lower a business’ taxable income, so the buyer will see tax benefits that they have never previously had. 

The buyer will see a bigger return on equity than any other financing buyout scenario as they are able to use the sellers assets to pay for the financing costs rather than their own. 

An LBO can improve a company’s market position and even save it from failure. 

For the seller, a key advantage of an LBO is the ability to the company even if it is not at its peak performance. As long as it still has a cash flow it can be sold. 

Disadvantages of a Leveraged Buyout

From a buyer’s perspective, LBOs have some risks. The main disadvantage is that there is a very slim margin for error, if the company is not able to pay the debt, they will get no return at all. 

If the returns of the acquired company do not exceed the debt financing costs or the cash flow is not sufficient enough to handle the high interest rates exacted by the LBO, there is a high bankruptcy risk. LBOs are especially risky for companies in highly competitive markets. 

LBOs have high fixed costs of debt. Often LBOs result in having to downsize a company.

LBOs are not appropriate for firms with high growth prospects or high business risk. 

Click here to read our article on How to finance a healthcare business.