Using venture debt - acquisitions or capital expenditures

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Large purchases of capital equipment – or even companies – are classic uses of proceeds from a loan. A manufacturing company generate additional EBITDA by adding production capacity or buying a profitable competitor. This EBITDA can be used to service debt used to fund the purchase.

With most startup software companies using the cloud so heavily, large capital expenditures are less common these days but debt is certainly an option when funding these purchases.

A venture loan can be helpful when funding an acquisition. At Columbia Lake Partners when we look at how much debt capacity a company has we consider enterprise value as one of the data points. An acquisition should add to the enterprise value which will increase the debt capacity.

Companies will want to know “how much of an acquisition can be funded with debt?” Or, more to the point, “can the entire purchase price be funded with debt?” My view of this is that typically it can’t because the buyer is, by definition, the highest bidder for a business. If the entire purchase is funded with debt the lender has no cushion in the enterprise value. A loose analogy would be taking out a mortgage for 100% of the value of a house.

The exception would be a case where the acquiring company had no debt currently and the combined company has sufficient debt capacity to fund the purchase price.

This doesn’t mean that a founder has to raise equity from her VCs to complete an acquisition. A seller may be willing to take a combination of cash (funded with debt) plus equity in the combined company, for example. This structure uses equity without having to raise additional cash from the VCs.

Company tip:

When looking at acquisitions get a quick market check on the amount of debt that might be available before committing to the cash component of your deal.