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Financing share acquisitions - the alternatives

Successful businesses are dynamic businesses, ready and willing to take opportunities as they arise, and growth is always on the agenda. Growing your business organically can take time, something which is often short-at-hand in today’s fast-paced commercial arena, so a viable and valuable alternative is to acquire another enterprise to strengthen your position. However, it’s not at all unusual for the purchaser of a company not to have, in readily available cash, the amount required to buy its chosen target company. 

So, what options do you have? Broadly, you have three choices:

1. Debt

Main advantage: interest on borrowing is tax deductible from profits
Main disadvantage: repayments have to be met regardless of the financial performance of the target company

The Companies Act 2006 abolished the restrictions on a private company giving financial assistance for the purchase of its own shares, meaning that the assets of the target company can be used to secure finance which opens up a variety of options including bank loans and asset financing. Much will depend on the appetite of lenders to lend to the type of business being acquired and the type and level of security the company can offer against the loan. A company with a strong cashflow or an asset-rich company may find it comparatively easier (and cheaper) to borrow money than a company with a weaker cashflow or little or no chargeable assets.

The cost of securing the loan will also influence a purchaser’s decision as to whether this is the right option, as will any restrictions on borrowing (for example, any pre-existing bank loans).

2. Equity Finance

Main advantage: if properly structured, an equity deal will allow managers of the new company to be taxed under the capital gains regime and avoid income tax charge
Main disadvantage: as shareholders, private equity providers (PEPs) have a greater say in the running of the business than a finance lender

For private companies, this often takes the form of a PEP injecting cash (in exchange for shares) into a company formed specifically to purchase the target, often with the managers of the new company acting as shareholders. Generally, the amount subscribed by the PEP for ordinary shares, alongside management, is only a very small proportion of the money that it invests and the rest is injected as shareholder debt, usually in the form of loan notes.

3. Funding through the share purchase agreement (Earn-out)

Main advantage: benefits cash-flow by deferring payment of the purchase price
Main disadvantage: does not give the purchaser a ‘clean break’ purchase 

An earn-out covers any mechanism where, on the sale and purchase of a company's shares, some or all of the purchase price is determined by reference to the future performance of the target company. Technically this is still a form of debt but payment is deferred and, if the company does not perform well, it may be reduced or not made at all. 

Earn-outs are typically used to secure the future services of a seller who is key to the target business (for instance, to preserve on-going relationships with customers).

For advice on mergers and acquisition, and all company commercial law, get in touch with Katherine Cereghino on 01788 557599 or at katherinecereghino@brethertons.co.uk.