A Buyer's "Ability to Finance" Matters as Much as Price and Structure

Summary: When selling a company, getting a high price is important. However, if you choose a buyer based only on the offered price, it is difficult to judge the substance of the deal. You need to also look at “Does this buyer actually have the money?”, “Whose money is being used for the acquisition?”, and “How will the nature of that money affect me and the company after the sale?”

Two things that change depending on the funding mix

Depending on what kind of money makes up the purchase price, two things change significantly. One is the likelihood of closing the deal, and the other is the operational burden the company must bear after the acquisition. A buyer may acquire using only its internal funds, or it may use its own borrowing or acquisition financing. It may also raise private equity capital, set up a project fund (a fund formed by gathering investors for a single specific deal), or build a co-investment structure with a strategic investor. Even at what appears to be the same acquisition price, the financing terms and the post-deal burden can be completely different. (An LOI is just an LOI, and in many cases it is not legally binding.)

The more external capital, the more closing conditions

If the price is paid with internal funds, there are relatively few approval procedures from external capital providers. On the other hand, if acquisition financing must be finalized, funding must be obtained from limited partners, or a project fund and strategic investor must be assembled together, the conditions that must be satisfied before closing (the point at which the price is paid, the shares actually transfer, and the deal is completed) increase. The more parties that need to be persuaded and aligned, the greater the chance that the schedule slips or the deal stalls at some stage.

In particular, with a project fund, the participation of a strategic investor is often a prerequisite for the financing. Yet finding a suitable strategic investor and agreeing on terms can be as difficult as creating another new deal altogether. The fact that a high price was offered and the fact that the money can actually be raised should be viewed separately.

External capital also affects price and structure

Because limited partners and financial institutions look at the safety and recoverability of their investment, they may find it difficult to simply accept a high valuation. They may require the seller to reinvest part of the sale proceeds, or to retain a certain stake and remain involved in management. Even if the nominal price is high, once the reinvestment amount, the retained stake, and the timing and terms of payment are taken into account, the value and risk the seller actually ends up with can differ. (It is worth remembering that it is hard to get your own money out before the borrowed money is repaid.)

If you are selling 100% of your shares and exiting completely, the first thing to check is whether the promised price will actually be paid at closing. Conversely, if you retain part of your stake and participate in management, the financing structure continues to have an impact even after the sale. Acquisition financing comes with interest and repayment burdens, private equity capital comes with target returns, and the pressure on the company to improve profits and cash flow increases. The cost of a high price may come back as a long-term management burden.

Even a buyer with plenty of money is no guarantee

A buyer with sufficient equity of its own does not always have a high likelihood of closing. The more a buyer spends a large amount from its own pocket, the more thoroughly it reviews, and because many opportunities come its way, its urgency for any particular deal may be low. Even if the working-level team has reviewed it for a long time, the deal stops if the final decision-maker does not approve it. The same goes for blind funds (funds raised first without a predetermined investment target): the deal must fit the fund’s criteria and priorities. And above all, there are fewer M&A market participants with a lot of money than you might think.

In deals involving small and mid-sized companies, the simple structure in which the buyer purchases with cash it has raised directly is common, so this issue may be less prominent. However, cases where the buyer took borrowing for granted and then fails to pass the financial institution’s review remain a key risk. An explanation that “we can borrow if needed” is not the same as a confirmed financing plan.

What sellers should check

• The source of the funds and the amount of equity committed
• The borrowing terms and whether external investors are confirmed, the required approval procedures, and conditions precedent (conditions that must be satisfied before the deal closes)
• If any funds have not yet been secured, who will provide them, when, and on what terms, and what happens to the contract if the financing fails
• If you retain a stake, how the post-acquisition interest and return burdens will affect dividends, investment, personnel, and management control

Of course, situations in which you can actually compare all of these are not common. Such comparison becomes possible only when the company is sufficiently attractive and there are many potential buyers in the market.

A high price is an important condition for a good deal, but it is not a sufficient condition. In some cases, a buyer with a certain financing plan and a simple structure may be a better counterparty than one offering a slightly higher price.

Frequently asked questions

Can I trust the price stated in the LOI?

An LOI (letter of intent) is usually not legally binding. Along with the price, you should check the source of the funds and whether the financing is confirmed.

Why do private equity buyers ask for reinvestment or a retained stake?

From the perspective of limited partners and financial institutions, the deal structure looks more stable when the seller shares the risk. Even if the nominal price is high, the amount the seller actually receives and its timing may differ.