Financing the Acquisition
Financing the acquisition of a franchise is not a slight affair, as with the legal fees, the initial fee, allocation for resource acquisition and various other expenses the cost raises significantly. Therefore financing often becomes mandatory in that situation. Mostly people concentrate on third party financing where they seek out investors and other debt or equity lenders for their financial needs. However, two of the most overlooked options are:
- The Target and its shareholders;
- The Internal Resources of the acquirer.
Rather than seek support from outside investors, it is suggested to try using either of the two above-mentioned or a combination of both to see whether the business can be launched without any third party support, yet should the needs not be met then definitely third party financing can be considered.
1. The Target and its Shareholders
The discussion here is to explain financing an Acquisition of a running franchise, so the acquirer should try to gain a comprehensive understanding of the target’s assets (this includes the real estate, machinery, equipment, vehicles, notes receivables, inventory, any patent or trademarks, and the franchise agreements). By identifying the target’s assets the acquirer will be in a position to understand how to use the assets to raise cash. The assets such as real estate can be used o provide funding through sale/leaseback transactions, the poorly performing units could be sold to reduce financial drag and losses and other assets such as trademarks and patents may be used as a security when dealing with the third party financiers. It is up to the acquirer to realize the worth of each of the assets and try to maximize the gain from them.
The role of the shareholders is such that the acquirer should realize their importance in providing funding for their purpose. The shareholders often provide seller financing on various terms and it is up to the acquirer to go into negotiations with them regarding this aspect. Similarly it should be realized how the shareholders will be paid, which includes discussing whether the shareholders will take their portion of compensation as earn-out or some other form of contingent payment. You must also negotiate over how the compensation can be structured to provide the maximum benefit to the buyer without putting too much at risk for the selling shareholders. Basic negotiation topics include:
- Discussing the optimum amount of earn-out;
- The period of time over which it will be paid;
- The line of income statement to which it will be tied;
- Any minimum or cap to be placed on the earn-out.
Finally, the acquirer must consider the selling shareholders’ willingness to accept equity in the acquirer in exchange for some or all of their stock in the target company. Acquirers can creatively formulate mechanisms using the willingness of the shareholders in accepting some portion of the purchase in stock, or issues around exchange rates, various forms (such as class of stock and options) and amounts of equity. These may reduce the cash outlay and help in financing the transaction.
2. The Internal Resources of the Acquirer
It is always better to avoid being indebted to others if you have enough capital or assets to sustain the transaction. The acquirer can leverage their own assets for paying the transaction as well. Similar to the procedure for assessing the target’s assets, the acquirer should consider leveraging their own assets. They should consider the existing shareholders and whether they are willing to provide additional equity to consummate the relationship.
Some of these resources include:
- Assets that can be turned into cash through sale/leaseback or other transactions,
- Revenue streams that can be monetized for cash today, and
- Existing financing sources which may increase their lending based upon post transactions financial numbers.
Either of these options is effective, and they should be evaluated as possible ways to finance the transaction. If the transaction holds promise then the acquirer and the shareholders may be willing to take additional risk in the hope for greater financial rewards of the acquisition.
After exhausting the stated options, often times “new money” is still required to have a successful transaction. Third-party financing comes into play in that scenario. It is recommended that the third-party financier be a good fit for the transaction. This means that the financier does not set unreasonable demands or causes difficulty by setting high interest rates or other causes other problems. When evaluating potential financing sources, the acquirer must consider the industry of the target, and the general terms of the deal.
There are various groups which provide financing. These groups can be differentiated along different aspects of their operations. The most typical categories for the groups are:
- Their usage of the funds (e.g. growth capital, liquidity, acquisition);
- The type of financing they offer (e.g. debt, equity, mezzanine debt);
- Special Industry preferences (e.g. retail, service, franchise, food);
- Their Size of financing (i.e. how much will they fun);
- The Level of post-transaction involvement (e.g. control, minority, passive); and
- Other key deal characteristics (e.g. international, turnaround).
The divisions in these groups give the acquirer the ideal opportunity to approach those financing groups which best meet their requirements. Rather than have one specific group offering financing to everyone, the customized financiers are more adept at understanding different customer requirements and prepare tailored financing packages for the acquirer.
Another advantage is that the customized financiers are often searching for financing options in their chosen field therefore if you have some specific financing requirements; you may find some party or the other willing to meet you close to your terms.
Acquirers are no longer restricted to their financing options so they should try diversifying their approach in gathering the necessary funds. The changing business atmosphere has helped in creating new financing options for people seeking funds in acquiring franchises. The franchisor has also become a prime source for financing aid. Similarly vendors have also at times acted as a financier to avoid losing business.
The International Franchise Association has on its Web site a list of debt and equity players who fund franchise deals, and organizations that host conferences specifically designed to help franchise companies locate financing. However, many of the best sources are available through research on the part of the acquirer, or by using a financial advisor who knows the players and types of the transactions they are interested in evaluating.
Understanding the Franchise Agreement
Due to the technical nature of the document it is best to have it legally reviewed by professional franchise lawyers to identify any hidden clauses or traps created by the franchisor to help them get the better position. It would be fool hardy to expect the franchisor to create a neutral agreement for the franchisee without their legal pressurizing.
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