Acquisition Financing: A Banker

1
Acquisition Financing A Bankers
Perspective

• Presentation to AFOA National Conference
• Carla Woodward
• National Manager, Aboriginal Banking
• RBC Royal Bank
• February 8 10, 2005

2
OVERVIEW

• Background
  
• Challenges of Growing Companies
• Importance of the Business Plan
• Managing the Acquisition Financing Gap
• Assessing Acquisitions
• the business case
• purchase terms
• purchase price
• financial metrics
• Ongoing Risk Mitigation and Monitoring
• Questions Discussion
• Reference Material

• Slide 3
• Slide 4
• Slide 5
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slides 10, 11, 12
• Slide 13
• Slide 14
• Slide 15

3
Background

• Acquisitions are a means for companies to grow at
  a rate faster than may be possible through
  organic growth
• . but, acquisitions can be fraught with risk for
  the company and its financiers
• studies suggest up to half of all acquisitions
  actually reduce shareholder value
• even in successful acquisitions, it typically
  take up to 2 years to successfully integrate the
  operations of the acquired company with the
  acquiring companys operations
• thus, a banker will evaluate acquisition
  financing requests with particular scrutiny!

4
Challenges of Growing Companies

• Challenges
• Relatively few SMEs grow into large mature firms
• Growth Organic Growth vs. Growth through
  Acquisition
• Successful Growth through Acquisition is not a
  given
• What differentiates the Winners?
• Strategic planning processes formal business
  plans
• Strong management
• Strong equity backing

5
Importance of the Business Plan

• Only 40 of all SMEs have a formal business plan
• Of Canadas 50 Best Managed Companies (Queens
  Centre for Enterprise Development Award)
• 77 have a formal business plan
• of the 77 with formal business plans, 97 are
  updated annually plan
• These figures are for SMEs in general given
  the additional challenges and opportunities posed
  by acquisitions, a sound business plan is even
  more important!

6
Managing the Acquisition Financing Gap

• Acquisitions may be financed via
• Any combination of
• Equity
• Angels
• Venture Capital
• Mezzanine Financing / Subordinated Debt
• Bank Financing
• while all financiers may expect to review some
  form of business plan, this presentation
  highlights the issues a Banker may typically
  expect a business plan for acquisition financing
  to address and is not intended to cover business
  plan requirements other financiers may have.

7
Assessing Acquisitions the business case

• Does the acquisition make sense from a business
  perspective?
• Industry considerations consolidation trends,
  cycles, structure
• Synergies via economies of scale in production,
  sales, R D
• Diversification of product lines, customers,
  distribution networks, geographic presence
• Consistency with core business
• Management expertise
• Execution risk
• Friendly or Hostile

8
Assessing Acquisitions purchase terms

• 2. What are the purchase terms?
• Purchase Agreement, due diligence reports,
  appraisals, etc.
• Terms and conditions of all financing for the
  deal
• Riskiest Deals with purchase prices paid 100
  cash and based on forecast vs. historical
  earnings
• Mitigating Risks by negotiating earn-out
  provisions or vendor take back financing using
  an accounting firm to assist with due diligence

9
Assessing Acquisitions purchase price

• 3. Is the purchase price reasonable?
• Valuation methods vary based upon the industry
  and features of the deal asset approaches,
  earnings/cash flow approaches, rules of thumb
  (eg. EBITDA multiples)
• Caution EBITDA multiples vary over time and
  between industries
• Comparisons should be made to other recent
  transactions, if possible
• Professional (CBV Certified Business Valuator)
  valuation of the target company and completion of
  due diligence

10
Assessing Acquisitions financial metrics

• 4. What are the financial metrics?
• Minimum 3 years historical financial statements
• Consolidated projections prepared by borrower
• Consolidated projections sensitized by the
  banker
• Base case model using average historical
  financial performance
• Worst case sensitivity analysis using cash flow
  only of acquiring company

11
Assessing Acquisitions financial metrics

• 4. What are the financial metrics (continued)?
• Downside risk variables how would borrower
  respond?
• Is the company's cash flow sufficient to service
  its proposed debt in both the base case and worst
  case analyses?

12
Assessing Acquisitions financial metrics

• 4. What are the financial metrics (continued)?
• Reasonable EBITDA cushion between the borrower
  and the bank-sensitized projections what is
  Break Even EBITDA
• where FCC 11?
• Other financial metrics include Funded
  Debt/EBITDA and TL/TNW, TL/Equity in some
  situations
• FCC Fixed Charge Coverage
• EBITDA - cash income taxes -
  unfunded Capex /- Corporate Distributions_
  Interest Expense scheduled principal
  payments in respect of Funded Debt
• Note Where material, operating lease payments
  should be added to EBITDA in the numerator and
  included in Fixed Charges in the denominator.

13
Ongoing Risk Mitigation and Monitoring

• Annual, updated Business plan will likely be a
  reporting requirement
• Interim (monthly or quarterly) financial reports
  should include comparison of actuals to plan
• Bank financial covenants based on the plan will
  likely be monitored on a monthly or quarterly
  basis and should be reviewed annually
• Loan structures term, amortization and
  committed/uncommitted should be appropriate to
  the risk
• Regular communication between bank and acquiring
  companys management is critical

14
Questions Discussion
15
RBC Royal Bank Reference Materials

• Managing for Growth report http//www.rbc.co
  m/newsroom/20031022smallbusiness.html
• Expanding a Business
• http//www.rbcroyalbank.com/busexpanding/
• Definitive Guides
• http//www.rbcroyalbank.com/business/definitiveg
  uide/index.html
• Business Banking Centres in Canada
• http//www.rbcroyalbank.com/business/locations/i
  ndex.html