Structuring SME merger and acquisition deals

News Flash

Hermes Capital provides Asset Based Loans to businesses in transition. Our funding is typically in the range of $500K to $10M.

Transition scenarios include business turnaround, start-up, rapid growth, restructures or, as demonstrated in this month’s case study below – business acquisitions.

Asset Based Lending is commercial financing to a business with up to two components: a revolving working capital facility supported by accounts receivable, and; a term loan facility that potentially doubles the availability of funds, and is secured by plant and equipment, and or real property (usually via a first or second mortgage).

This month’s case study demonstrates how Hermes fills the gap left by the banks and other institutions in the SME market for commercial finance.

Transitional Situation

Funding acquisitions in the SME space is very different to the corporate space.

True corporate finance (as practiced by private equity, investment banks and the corporate finance departments of trading banks) allows for loans against “enterprise value” – typically multiples of EBITDA.  Rules of thumb are applied for LVRs and debt pay back periods – but this approach is not available to SMEs.

This is for a number of reasons, including:  lack of expertise on the banking side to be able to adequately assess this kind of risk; a lack of quality data on the businesses side for reliable enterprise values to be determined, and; absence of the secondary markets for debt and equity instruments that usually underly these transactions.

The gap in the market for commercial finance

Hermes was recently approached to consider a Management Buyout of a strongly performing manufacturing business.

The business had revenue of $10M and an EBIT of $1.25M.

The price for the business was $2M net of employee entitlements. The buyers also calculated they would need a further $1M in forward moving working capital. Total requirement $3M.

The buyers had sufficient equity in their properties to support a combined $0.75M in new borrowings towards the acquisition.

The finance broker was seeking funding against “going concern” value of the business – in reality an “enterprise value”/ corporate finance lend – simply not available in the SME space.

Also problematic is the section of the corporations law precluding the use of the assets of the business as security to finance the acquisition of the shares of that same business.

Asset-Based Lending Solution

Hermes proposed a solution that would be workable – albeit, not exactly what the client nor the business vendor was seeking.
The three part structure looked like this:

1. Debtor finance for the forward going working capital.  That was the easy part.
2. $750K term loan secured by second mortgages on purchaser’s properties – to fund up front payment on vendor financing terms (see below).
3. A proposal for the vendor to fund the balance over 24 equal monthly payments.  Hermes would make these payments to the vendor out of proceeds of debtor finance facility under a tri-partite agreement between buyers, vendors and Hermes.  Hermes proposed the Vendor would retain security over the business behind Hermes until 24th payment made.  Hermes also allowed the vendor priority on P and E (manufacturing plant) as a sweetener.

Outcome

The management team/buyers now have the means to complete the business acquisition. The outcome is also good for the vendor – it is the management team who have the best insights into the potential of the business and the credibility of its reported track record – and therefore best positioned to appreciate the true value of the business.