Funding for Acquisitions More Scarce but Still There
Anil Sharma learned how to buck a trend when he became an entrepreneur this year. He needed debt financing to buy up the assets and receivables of a Burbank studio equipment company in Bankruptcy Court, and debt financing had become a scarce commodity in the preceding months.
The Los Angeles businessman got his deal done anyway, and his success illustrates two important new facts about business finance in California and across the nation:
* Banks and other institutional lenders, shaken by the slaughter of the dot-coms over the last year and the economic slowdown underway, no longer line up eagerly to finance leveraged buyouts or mergers and acquisitions involving most small and mid-size companies.
* Entrepreneurs can still make deals if they learn the new rules of finance and come to the table with their financing in hand.
A credit crunch prevails not only for ordinary business borrowers but also for entrepreneurs who depend on debt financing to drive their buyout or merger campaigns, leaving all but those with the healthiest balance sheets with little choice but to bide their time until things loosen up.
But those who have the financial muscle to operate in the new environment find plenty of attractive targets for acquisition, as Sharma’s experience shows. For them, it’s a buyer’s market as businesses eager to sell cut their prices to attract buyers.
By one estimate, prices for small and mid-size businesses may have dropped 15% to 20% in the last year, with more price-cutting on the way.
Entrepreneurs must also structure their deals in creative new ways to get them done. Sharma and three silent partners, for example, enticed Sanwa Bank to back their $14.5-million deal by ordering, at their own expense, a sophisticated appraisal of their target company’s equipment--proving its inherent value and its potential to generate revenue.
They also dug into their own pockets for more equity capital than they might have had to show a year ago for the same deal--more than 30% of the deal, according to Sharma.
The result: In January, armed with $9 million in debt financing from Sanwa Bank, the partners bought the receivables and rental movie-making equipment of Matthews Studio Group, a longtime supplier to Hollywood that filed for Chapter 11 reorganization last year. The company now operates as Hollywood Rentals Production Services, with Sharma serving as president and chief executive.
The keys to the deal, Sharma said, were the equipment appraisal, which took seven weeks to complete, and the equity capital ponied up by the partners.
“In today’s environment, if you’re going to get a deal done, first of all it has to be sound,” Sharma said. “We had to make sure that the assets we were buying were real assets with proven cash flows. You have to work harder to get your financing. You also have to be patient.”
In all, he said, it took about 90 days to close the deal--far longer than he and his partners expected.
The wariness of banks and other institutional lenders to finance mid-market mergers and acquisitions, or M&A;, first became evident in the months following the pullback in the stock markets a year ago. The more recent slowdown in the economy makes lenders even more skittish, giving entrepreneurs a difficult task in rounding up debt financing.
According to Thomson Financial Securities Data, $67.3 billion in leveraged loans, most involving big companies, closed during the quarter ended April 30, down 23% from the $87.7 billion closed in the same period last year.
A reading of the activity among mid-size companies comes from S&P; Portfolio Management Data, a provider of data on leveraged finance, which counted only 26 buyouts or mergers involving mid-size companies nationwide in the first quarter of this year. The data defines mid-size companies as those whose revenue does not exceed $500 million. The total value of those deals came to $1.84 billion, and none exceeded $150 million.
The first quarter a year ago, in contrast, saw 56 deals consummated, with a total value of $4.3 billion, according to S&P; Portfolio Management Data.
“Business sellers are coming off the 1990s, and their asking prices are still high,” said Mitchell Drucker, senior vice president of CIT Group in New York, a leading player in the leveraged-buyout and M&A; marketplaces.
“And because leveraged lending activity in general has come way down, this means buyers have to put more equity or more subordinated debt into the deals--and because of this, fewer deals are getting done,” Drucker said.
Eighteen months ago, lenders commonly backed buyout and merger deals with debt ranging from four to five times earnings before interest, taxes, depreciation and amortization, Drucker said. Now the multiples range from two to three.
“As a hard-asset lender, our main concern is whether we can get our money out of assets like equipment, and we’re relatively indifferent as to whether the buyer puts up more or less equity,” Drucker said. “But for cash-flow lenders, the percentage of equity is on the rise from 20% not long ago to 40% or even 50% now--and the ‘plug number’ in many deals is the equity.”
Even when they bring hard-asset lenders into the picture, however, entrepreneurs such as Sharma and his partners find that their willingness to put up equity capital can make all the difference in doing a deal. Three or four other investor groups made bids for Matthews Studio Group but couldn’t piece together the financing, Sharma said.
“We got the deal because we had a commitment for the bank financing in hand,” Sharma said. “Two days before we went in front of the Bankruptcy Court, we had the appraisal in hand, our own equity in hand, and our bank commitment in hand--and we got what we wanted.”
NEXT: How old-fashioned business caution made an Oakland businessman a winner in the new financing environment.
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Juan Hovey can be reached at (818) 709-6420 or via e-mail at jhovey@gte.net.
