Under what circumstance would you use debt to finance your acquisition?

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August 14, 2020

by a searcher from HEC School of Management, Paris in Bristol, UK

The Harvard and Stanford search models typically reference a hybrid financing approach - equity + debt + seller note. As I speak to more folks, I am learning that many acquisitions are also done entirely using various types of debt (asset financing, invoice discounting, etc) and seller earn outs.
Has anybody raised the acquisition capital to buy without equity, (i.e. using entirely debt)? What have you found to be the pros and cons of this approach, and what ratios/metrics would you need to look at to assess whether the deal would make sense in the long term? Also, how would you deal with the lack of obvious candidates for a company board to give advice if you carry no investors?
Sorry for the numerous questions!

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commentor profile
Reply by a lender
from California State University, Sacramento in Seattle, WA, USA
If you are using SBA for a self-funded search or going conventional with a traditional search and looking for bank debt, most lenders are going to require a certain amount of equity. Rule of thumb, for SBA Sr. Debt, the SBA requires a MINIMUM of 10% equity on total project costs. For conventional deals a high-level rule of thumb is 30% - 40% Equity required for Traditional search (non-recourse). For conventional debt with a personal guaranty, let's say 30% - 50% Equity will be required. This is all high-level and dependent on debt coverage and ebitda turns but gives a good starting point. There are other ABL and Hard Money options but not my specialty. redacted
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Reply by a searcher
from Yale University in Moscow, Russia
Chin, without strong connections with lenders that's almost impossible. Almost no one is doing that.

From a seller standpoint, why the hell they will sell it if they can just leverage it in the same way as you would do, get the money in their hands and at the same time also keep the business in their hands? From the bank standpoint, why they would give money to someone to acquire a business w/o them having any skin in the game?

Debt to equity ratio varies across the countries, but in general searchers make acquisitions with 20-80% being debt and the rest being equity of various forms (part of which sometimes might be structured like debt for tax reasons).
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