Financing: essential component for a successful buy and build strategy
More and more investment companies and companies are opting for a buy and build strategy To grow faster. Unlike organic growth, this strategy offers the opportunity to achieve economies of scale and synergies through acquisitions. This can increase the total value of the group beyond the value of the individual companies.
In recent years, Match Plan has successfully supported various investment companies and companies in identifying potential acquisitions, carrying out acquisitions and attracting the right financing packages. In this article we will discuss the financing of a buy and build strategy and the key points of attention.
What does a buy and build strategy entail?
1. Growth through strategic acquisitions
A buy-and-build strategy focuses on growth through targeted acquisitions rather than organic expansion. A platform company strategically acquires (smaller) companies with similar or complementary businesses. This creates synergies, economies of scale, and a stronger market share.
2. Value creation for investors
Investment firms often employ this strategy because it allows them to create value in a relatively short time. Within an investment horizon of five to seven years, they can achieve higher returns through acquisitions and efficiency improvements.
3. Challenges in implementation
While a buy-and-build strategy offers growth opportunities, its implementation presents several challenges. A significant hurdle is the integration of acquired companies. Differences in corporate cultures can lead to employee resistance, which can reduce productivity and increase employee turnover.
4. Complexity of IT integration
Besides cultural differences, different IT systems pose a common challenge. Incompatible systems can delay integration and incur additional costs, negatively impacting business operations.
5. Financing as a critical success factor
A well-thought-out financing structure is essential for the success of a buy-and-build strategy. The right financing determines not only the speed and scalability of acquisitions but also the extent to which value creation can be realized.
How do you finance a buy and build strategy?
As described above, the chosen financing can significantly impact the buy-and-build strategy. Therefore, it's essential to carefully consider the key factors when choosing financing. The three most important aspects are explained in more detail below: the type of financier, the financing mix, and the covenants.
1. The financier
The choice of a financier is crucial in a buy-and-build strategy, as it influences both the initial and future acquisitions. Bank financing is often used, possibly combined with mezzanine financing or debt funds. Below is an explanation of the various financing options and their key differences.
Bank financing
Bank financing refers to financing provided by banks. This type of financing is characterized by lower interest rates and relatively low initial leverage. Leverage refers to the ratio of outstanding debt to EBITDA. Furthermore, bank financing often requires more collateral and detailed financial documentation.
Mezzanine financing
Mezzanine financing is provided by specialized debt funds. This type of financing often has higher limits and combines the advantages of debt and equity with flexible terms.
Flexibility: banks versus debt funds
Banks and debt funds take different approaches to financing flexibility. Banks operate under strict regulations and guidelines, often limiting their ability to deviate from standard solutions. Debt funds, on the other hand, are less regulated and can therefore offer more customized solutions. This allows them to offer financing that better suits a company's specific needs. This difference in flexibility is primarily reflected in the loan amount, covenants, and repayment obligations.
International Finance: Banks vs. Debt Funds
Furthermore, it's often more difficult for banks to finance international acquisitions for SMEs, while debt funds can, depending on their investment criteria. This is particularly important for a buy-and-build strategy with international ambitions.
Guarantees and risks
Banks and debt funds also have different perspectives on collateral and covenants. Banks typically require extensive collateral, such as a lien on real estate, accounts receivable, and inventory, due to regulations and risk aversion. Debt funds, on the other hand, generally require less or even no collateral. This is because they often trade collateral for flexibility and higher interest rates.
Strict versus flexible covenants
Banks are also stricter regarding covenants and often require both financial and operational covenants. Furthermore, banks require detailed financial documentation. Debt funds are often more flexible in this regard and often focus solely on cash flows.
Interest costs and payment structure
As a result, the interest rate on debt funds is often higher than the interest rate on banks. Banks often charge an interest rate based on the 3-month EURIBOR plus a margin of 3 to 4%, while debt funds often charge an interest rate based on the 3-month EURIBOR plus a margin of 5 to 8%.
There's also a difference in how the interest is paid. With bank financing, the interest is often due monthly. With mezzanine financing, there's usually the option to pay (part of) the interest at the end of the financing term. During the loan term, the interest due is added to the financing, increasing the debt on which the interest is calculated.
2. Creating the right financing mix
A buy-and-build strategy requires a well-balanced financing mix, or the ratio of different loans. A combination of linear and interest-only loans is often used, each with its own advantages and disadvantages. The characteristics and impact of both types of loans are explained below.
Linear loan
A linear loan is a traditional loan that is gradually repaid over the term of the loan. The financing costs consist of both the repayment obligations and the interest due.
Advantages of a linear loan
- Gradual repayment reduces the debt over the term.
- Future cash flows can be used to repay the loan.
- Lower leverage as the loan is repaid, making it easier to raise additional financing.
Disadvantages of a linear loan
- Higher monthly financing costs due to mandatory repayments.
- Less available cash flows for further acquisitions within the buy and build strategy.
Interest-only loan
An interest-only loan, also called a bullet loan, is a loan that is repaid in a lump sum at the end of the term. During the term, the financing costs consist solely of the interest due.
Benefits of an interest-only loan
- More liquidity available during the term, facilitating further acquisitions.
- Faster growth possible because cash flows are not burdened by interim repayments.
Disadvantages of an interest-only loan
- Higher total interest charges, because the debt remains fully intact until the end of the term.
- High final repayment, which requires sufficient liquidity at that time. This often requires raising new debt financing, which limits leverage.
- Balance between both loans
When financing a buy-and-build strategy, it's crucial to find the optimal balance between linear and interest-only loans. This ensures stable cash flow and the necessary financial flexibility to successfully implement the growth strategy.
3. Covenants
In addition to choosing the financier and the financing mix, it's important to make sound agreements about covenants. These agreements can have a significant impact on both the speed and continuity of the buy-and-build strategy. Below, we discuss the most important covenants.
Leveraged ratio
The leverage ratio represents the ratio of (net) debt to EBITDA and is a commonly used financial covenant. Banks typically finance leverage of 2.50x, but depending on the buyer and sector, they may be willing to go up to 4.0x. Debt funds are less risk-averse and often apply higher leverage of around 3.50x, which can even reach 6.0x in certain sectors. In a buy-and-build strategy, it's essential to use normalized LTM EBITDA as a basis to ensure accurate assessment of acquisitions and rapid synergy benefits.
Debt Service Coverage Ratio
The Debt Service Coverage Ratio refers to the ratio of financing expenses to operating cash flow. This ratio should always be at least 1.00x to ensure sufficient liquidity is available to meet financing expenses.
Maximum debt of banks
Banks often impose restrictions on raising additional debt, which can impact the speed and continuity of a buy-and-build strategy. This can lead to future acquisitions being unable to be financed. Therefore, it's crucial to consider this when choosing financing. Debt funds apply this restriction less strictly and generally assess new financing based on the leverage ratio, which in some cases offers more room for further growth.
The right financing as the key to success
In short, securing suitable financing to implement a successful buy-and-build strategy involves many considerations. Therefore, it's important to carefully consider the various options.
We have specialized knowledge in financing buy-and-build strategies, enabling us to support investment firms and businesses in this decision. If you require support, our team of advisors is available to assist you.
Contact
Please fill in your contact details and we will contact you as soon as possible.
"""*"" indicates required fields
Telephone
Would you prefer to contact us directly by telephone?
Then you can call +31 85 013 00 75.
- Over 30 years of experience
- 100% independent advice
- 1000+ entrepreneurs guided
Related blogs
No obligation Advice
Over 30 years of experience
Please feel free to contact us
advisors for an introduction.
✔ Business sale
✔ Company takeover
✔ Acquisition financing
✔ Independent assessment