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Why is “How do I pay for an acquisition?” even a question?

by on September 25, 2013

Money PuzzleThis question was posed to me recently:  Why is, “How do I pay for an acquisition?” even a question?

I believe that this question, and the lack of a good answer to it, is a big reason that small businesses do not consider M&A as a viable growth option.  Without an obvious answer as to how to pay for a deal CEOs don’t even LOOK at acquisitions thinking, “I can’t afford it”, and that’s simply not true.

If not having an answer to this question creates an obstacle than you’re getting bogged down in the “How” and losing site of the “Why”.

Why?  Because acquisitions are the fastest way to grow your revenues and make you a big player in the market.  I discuss this in-depth in my post, Size Matters.

As for the “how”, there are several options:

Cash is King

If you have cash on hand like the big companies then this is an easy answer to the question.  But if you’re a small company buying a smaller company, you might be able to pay for the deal from cash on hand, or at least a portion of it.  The rest can be facilitated in other ways, discussed below.


Debt is a great way to raise cash.  Obtaining debt financing can be a great way to finance revenue growth.  First, you create a relationship with your bank and you’ll need that as you grow.  Second, you essentially pay for the acquisition through the revenue growth of the acquisition.  Third, interest rates are low right now.  However you need to be confident in the financial projections that show you can cover the debt service and live within any financial covenants that are a part of the deal.

Equity is always a good option

If you’re a public company this is a bit easier in that your market value is established and the shares have a price.  If you’re a private company then you’ll have to negotiate two valuations: the target’s and yours.  But it’s doable.  Equity allows for the target company and its shareholders to take a lower valuation today than it would ideally like in the expectation that the combined company will generate a much bigger return at some point in the future.

I admit that merging two private companies, and their respective cap tables, is challenging.  Someone once told me that it’s easier to negotiate peace in the Middle East than it is to merge two private company cap tables.  If that was true than I need to take my team from Lumension to the Middle East because we successfully did that with the merger with Securewave in 2007.

Private company equity can be either common, preferred, or a combination.  Trustwave is a great example of a company that has created tremendous growth through acquisitions primarily using common stock as currency.

Combination of cash and stock

You don’t have to do one or the other.  A combination can be a number of different options, like stock today and cash in the future or vice-versa, mostly cash or mostly stock, or equal cash and stock.  But if you’re a private company, any cash component in this equation locks in a hard valuation of both companies, rather than a relative one in an all equity deal.  So you might have to hire a firm to do an appraisal of your company to set your valuation.


Earn-outs are a great way to address the gap between offer price and asking price. According to Wikipedia, an earnout is when the seller must “earn” part of the purchase price based on the performance of the business following the acquisition. In an earnout, part of the purchase price is paid after closing based on the target company achieving certain goals.  This is essentially seller financing.  It’s a great way to limit the performance risk of the target company be essentially telling the seller, “I’ll pay you what you want if you do what you say you will.”  A typical earnout takes place over a 1-3 years after closing of the acquisition and may involve anywhere from 10% to 50% of the purchase price being deferred over that period.

The big issue around earnouts is control.  The seller wants the control necessary to ensure it does what it can to do what it said it would do.  If the earnout metrics are financially based this is really hard.  Are you measuring top line revenue or bottom line profit?  Who controls the sales team? Is the product integrated?  Are the metrics related to all products or just the acquired product? Do you integrate the technologies, products, and sales teams or do you leave them all separate until the earnout is over?

The best way to structure an earnout is to create the metrics around issues that are not financially based, are within the control of the seller, and work for the betterment of the overall company.  Examples of this are earnout metrics around product development and integration.  This is what I did when structuring an earnout in Lumension’s acquisition of Securityworks in 2009.


There are a lot of ways to pay for an acquisition.  Many CEOs think they have to have all of that figured out before they start but they don’t. It’s good to be comfortable with the options before proceeding but it should NOT be an obstacle to using M&A as a growth vehicle.  They need to be aware of them, and their own limitations, but they will tailor the financing to meet the deal. They may not be able to do all of the options but they can probably do one of them. Once they understand their limitations and capabilities they can find the right target to buy because it will act as a filter.   Find the right target for you under your circumstances.

If you’re wondering how you build a company that you can sell for a premium in a few years, contact me to discuss the Valuation Amplification Process.

I also invite you to download the white paper and learn the 5 step process on How to Quickly Increase Your Valuation by Thinking and Acting Like A PE Firm.

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