Marc Fecher, director at Devonshire Corporate Finance (DCF) offers advice on how businesses can raise money during our current difficult economic times.

According to CMBOR, last year was a new record for deals in the UK buyout market at £45.8 billion, with a large number of over £100 million deals. In the first quarter of 2008, just £7.2 billion of deals have been recorded. With the general concerns over the credit crunch and the knock on effect of rising oil prices, it is likely that 2008 will see a reduction in the overall number and value of leveraged MBO’s as funding these transactions becomes increasingly more difficult.

The banks themselves are experiencing substantial problems with liquidity as a result of the sub-prime lending debacle. Given this backdrop, it is increasingly difficult to raise money for transactions. However, for the right deal, at the right price, funding is still available. It is all a question of understanding what type of deal and structure to go for and avoiding the common pitfalls that often occur when seeking funding.

Before approaching the market, it is important to establish what the funding is needed for. Is it for expansion, an acquisition or for restructuring? From our experience, lenders in the current climate are focusing on lending to quality businesses with a track record of sustainable cashflow and strong proven management teams.

According to research commissioned by DCF, the majority of managers (52%) said they either have or would consider buying a business they work for, given the opportunity to do so. The reason for this can be seen in this simplified example, which, ignoring costs and interest, demonstrates why an acquisition/MBO is attractive. If, for example, the business was making £5 million EBIT (Earnings Before Interest and Tax) per year and the MBO team could buy it for five times EBIT at £25 million, which they funded using a mixture of bank debt, deferred consideration and equity funding, the business would, over the next four years, repay £3 million a year of bank debt. If by year four, the company’s EBIT increased to £6.5m when the business was eventually sold on a multiple of six times EBIT, it would be valued at £39m. If the outstanding £13 million of funding was repaid, there would be £26 million to be divided between the equity providers and the management team.

This is a compelling and clear example of why owning, growing and selling a business is a popular option.

Sources of Funding

There are many ways to fund a business acquisition. Funding sources are categorised into either debt or equity.

On the debt side, the potential sources of funding are often more straight forward: namely asset backed bank loans, senior debt, mortgages or mezzanine finance. In most transaction structures it would be common to mix both forms of finance to optimise the return for the acquirer. The advantage of funding a transaction through debt is that interest payments are tax deductable and it is usual that the manager retains a greater ownership of the business. However it should be remembered that interest rates can fluctuate, there is likely to be some restriction on dividend payments and there are strict covenants to be complied with. In certain instances the debt provider may require personal guarantees which may increase the risk to the MBO team.

Finance through equity also has its pros and cons. On the plus side, it can improve cash flow and provide additional experience to the management team if a non-executive director is appointed. An equity investor could also provide additional funding for the business should an acquisition or growth opportunity arise. However, there is a price to pay as the use of external funding can result in a loss of control. Above all, it is worth remembering that you are asking investors to take a risk when providing equity for your business. Given the risk involved the returns required are greater than straight debt so equity finance can be an expensive way of funding a business.

My advice to any business looking to secure funding is to summarise the main objectives of the fundraising in a profile and ensure that you know how much money you need to achieve your plans. When meeting with funders, it is important to understand their objectives and match the funding requirements to their needs.

Raising finance can take some time - so be patient. A methodical, complete search exercise will provide more appropriate funders than a rushed one. And, don’t spend too much time on the fundraising at the expense of looking after your existing business. Even with a robust business plan and a strong offering, fundraising is never guaranteed. Have a ‘Plan B’ in place to ensure that the business remains strong in case the funding does not materialise.