Show Me the Money

by Marty Kirshner, Gray, Gray & Gray, LLP 

A Primer on Financing Options for Acquisitions

A business acquisition can be a pivotal moment in the lifecycle of a heating oil or propane company, offering the potential for rapid growth, diversification, and enhanced competitive advantage. However, funding such acquisitions can be a complex process, requiring careful consideration of various financing options. Over the years, we have guided multiple clients through these options, helping them to select the most advantageous and sustainable route for their specific situation. Let’s explore different financing options for business acquisitions, including their benefits, drawbacks, and key considerations.

Cash Financing

Cash financing is the simplest form of acquisition financing, where the acquiring company uses its available cash reserves to purchase the target company. This method is straightforward and does not require taking on debt or diluting ownership through issuing new equity. However, it requires the acquirer to have significant cash reserves, which may not always be feasible for a small- or medium-size energy business. Additionally, utilizing cash reserves might deplete resources needed for other operational activities or future investments.

Consideration must be given to the impact on liquidity and the acquiring company’s ability to finance ongoing operations and future growth; balanced against the “opportunity cost” of potential returns from alternative investments (such as equipment, software, personnel) for which the cash could be used.

Debt Financing

Debt financing involves borrowing funds to complete the acquisition. This can take various forms, including bank loans, mezzanine financing, or issuing bonds. Debt financing allows companies to leverage their capital structure, potentially enhancing returns on equity. However, it also introduces interest obligations and repayment schedules that could strain cash flow. The terms and availability of debt financing will depend on the acquiring company’s creditworthiness and the overall economic conditions.

We help energy clients in buying mode to evaluate the cost of borrowing and ensure the acquisition’s projected cash flows can cover debt service. It is also important to understand any covenants attached to the loan, such as restrictions on further debt or requirements for financial ratios.

Equity Financing

Equity financing involves raising capital through the sale of shares in the company. For an acquisition, this could mean issuing new shares to either the public or private investors. While this method does not impose debt obligations, it dilutes current shareholders’ ownership and may affect control of the company. Equity financing is suitable for companies that have a strong growth potential and can attract investors but wish to avoid the risks associated with increased debt levels.

Before entering an equity finance agreement, it is essential to assess how much current shareholders’ ownership will be diluted and its impact on control. In addition, the ability to raise equity depends on market conditions and investor appetite for the company’s shares.

Seller Financing

Seller financing occurs when the seller of the business takes on the role of the lender, allowing the buyer to pay the purchase price over time. This method can be advantageous for both parties, offering easier qualification and more flexible terms than traditional financing options. It also demonstrates the seller’s confidence in the business’s profitability. However, the buyer must ensure that the business generates sufficient cash flow to meet payment obligations, and the seller must assess the buyer’s creditworthiness.

Payment terms in seller financing are especially important and should be negotiated so as to align with the cash flow projections of the business post-acquisition. Also, just as with bank financing, the buyer and seller must establish what assets will secure the financing and the recourse if payments are not made.

Leveraged Buyout (LBO)

A leveraged buyout is a specific type of acquisition where the purchase is primarily funded through debt, using the assets of the target company as collateral. LBOs can be highly effective in acquisitions where the target company has stable, predictable cash flows and tangible assets. The high leverage can significantly enhance returns but also increases the risk of financial distress if the company’s performance falters.

The buyer must carefully analyze the target company’s financials to determine how much debt it can sustain and have a clear plan for reducing debt over time or selling the company at a profit to ensure financial stability.

Joint Ventures or Partnerships

Forming a joint venture or partnership for the purpose of acquiring another energy business is another financing option. This approach involves teaming up with another company or investor(s) to share the cost and risks of the acquisition. It can provide access to additional resources, expertise, and capital. However, it requires aligning interests, strategies, and management practices, which can be complex.

Part of the pre-sale negotiation must include defining roles, contributions, and profit-sharing arrangements clearly and legally. That will help ensure that all parties have aligned goals and complementary strengths.

Financing a business acquisition requires a strategic approach that balances the need for capital with the long-term financial health and strategic goals of the acquiring company. Each financing option presents unique benefits and challenges, making it crucial for heating oil and propane companies to evaluate their financial position, risk tolerance, and strategic vision.

By understanding the available financing options and considering the key factors involved, the owner of an energy company can make informed decisions about acquiring competitors and achieve strategic growth objectives. A trusted accountant can provide you with the necessary guidance and expertise throughout the acquisition process, ensuring they secure the most favorable financing terms and set themselves up for long-term success.

Marty Kirshner leads the Energy Practice Group at Gray, Gray & Gray, LLP, a business consulting and accounting firm that serves the heating oil and propane industry. He can be reached at (781) 407-0300 or mkirshner@gggllp.com.

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