New trends: How to use factoring in acquisition finance

Financiers of M&A Deals went through a turbulent year - with ups and downs. A brilliant first term was followed by a poor second term. The black outlook has lasted into the first term 2008 influencing the midcap-market, which is also confronted with a structural problem. Apart from a growing number of specialized private equity investors, M&A Deals still have a unique position within the investment range between 50 and 250 million Euros: the deals are too small for investment banks and often too big for smaller regional banks. This situation brings up opportunities for new financing forms like factoring. In this article, Klaus Taube, CEO of Eurofactor AG, looks at the big picture.

Factoring can be used in different phases of company acquisitions: before, during or after an M&A phase. There is a wide range of possibilities for the financial or private investor.

Already in due diligence in preparation of an acquisition, the know-how of a factoring company can be used to examine and analyze the receivables portfolio of the targeted enterprise.

Hidden risks in receivables management can be revealed to find the true value of the receivables portfolio. The result is more transparency and an improved knowledge of the targeted company's fair value which again supports the negotiating position of the bidder.

Factoring releases liquidity that offers more room to manoeuvre or can contribute to the realization of Leveraged Buyouts (LBOs) - Management Buy Outs (MBOs) and Management Buy Ins (MBIs). Before selling a company its debt-free net present value can be increased by redeeming its liabilities that bear short term interests achieving a potential price increase in sale.

Regarding spin-offs, similar effects can be achieved. Through selling the receivables of a spin-off (e.g. a MBO), the ratio of debt financing can be reduced. Hence the financial independency is enforced at a preliminary stage without diluting the ownership of the MBO. Investors can use factoring as well in order to realize exits from middle-sized engagements: for example to reduce bridging loans, high-interest liabilities or mezzanine-loans minimizing debt financing costs.

On the investor's side, the released cash flow can be used as a financial lever for self-financing purpose, reducing the percentage of equity employed without borrowing additional external funds. This advantage is particularly interesting for high-yield orientated private-equity companies.

It has generally become apparent that factoring is a flexibly applicable module of finance concerning acquisitions. The funding of structured transactions can be completed by factoring along with credit financing or private equity capital. Large M&A transactions can be formed by a finance syndicate that integrates two or three factoring companies.

In general, factoring is a helpful finance tool supporting the growth phase of smaller companies and in the same time preserving their financial independency. It is therefore particularly of interest for MBOs, MBIs, and even turnarounds.

Factoring contracts are mainly arranged for long-term engagements, focusing on a sustainable partnership that gives the client financial independency. Factoring optimizes the receivables management and helps to stabilize the cash flow. This gives especially smaller companies, such as MBOs, with rapidly growing turnovers a more reliable basis for their financial planning.

As the funding by a factoring company is based on the purchase of the client's receivables and grows parallel with the client's turnover, factoring is a "breathing finance" that keeps enterprises more flexible in their development. Hence their financial planning is not exposed to the risk of sudden disruptions such as terminations of bank loans or outplacements of private equity capital. Factoring can therefore be as well employed as a follow-up financing in succession of a venture capital engagement.

The arrangement of factoring contracts and processes must take into account the general complexity within structured transactions. This is particularly true for cross-border transactions.

Long-dated terms of finance up to seven years are to be considered by the factoring institute, just like special covenants, such as exit clauses regarding breaches of financing conditions.

The frequently higher risk exposure in M&A deals, such as a high funding level or contractually determined exits need to be incorporated into the factor's risk strategy.

In this context the factoring company must also validate the homogeneity of other investors (generally banks, private equity companies or the management of the M&A target): Do the investors seek a long-term cooperation or short-term profits? How are the risks covered by the partners, and how to validate the risks?

It is therefore important for the factoring company to have close cooperation with banks and / or private equity companies and to extend the shared know-how in order to develop customized solutions.

Even though factoring still plays a minor role in acquisition finance at present, it will gain importance mainly in the midcap M&A market. Factoring institutes are adequate partners for private equity investors, as factoring contributes complementary to leveraged finance. As a result of the subprime crisis, PE investors just as banks have an increased interest in an optimized risk assessment and distributed risk coverage of new engagements. Especially for turnaround-finance factoring is used increasingly by PE companies. Last but not least factoring has the potential to participate increasingly in cross-border transactions due to the innate knowhow of factoring companies accompanying export and import business.

www.factorscan.com