Funding an agency acquisition: how much can you safely commit?

In short: The funding requirement is larger than the price: completion cash, fees, fixed deferred payments, possible earnouts, integration spend, retention and the liquidity the combined business needs. Each source brings obligations: debt is serviced, investors have rights, seller funding is still owed and shares in your business ask the seller to value you. Separate what the business is worth, what funding is available and what the combined business can sustain. Build a sources and uses schedule, phase the payments, find the point of greatest liquidity pressure and test it against a downside, because EBITDA is not cash.

The complete funding requirement

Buyers who fund only the completion payment discover the rest later. The requirement includes:

• Cash at completion, after the equity value adjustments, plus any escrow the buyer funds.
• Transaction fees: advisors, lawyers, due diligence, financing costs.
• Fixed deferred consideration, on its dates. Deferral changes the timing of payment. The obligation is unchanged.
• Earnouts, which are contingent but must be fundable when the business performs, since that is exactly when they fall due.
• Integration spend: systems, premises, rebranding, redundancy, the cost of achieving synergies.
• Retention arrangements: bonuses and incentives for the people the deal depends on.
• Operating liquidity: the working capital and headroom the combined business needs through its seasonal cycle, including the target’s own requirement, which may have been funded by its founders informally.

Three things are not funding. Client deposits and other client money held by the target are owed against delivery. Cash the target needs to run its own cycle is not surplus. Cash that will leave in the equity value adjustments is the seller’s.

Sources, and what each one commits you to

Do not count a source twice. Seller deferred consideration is both a source of funding at completion and a use of cash later; it belongs in the time phased schedule and should be left out of the completion sources.

Valuation, available funding and sustainable affordability

These are three different questions, and a deal is safe only when all three are answered. Valuation is what the business is worth to you, from underwriting. Available funding is what you can raise: cash, debt a lender will advance, investor capital, what the seller will defer. Sustainable affordability is whether the combined business can meet every obligation on its dates, through a seasonal cycle, in a weaker year, without starving the existing business or the one you have bought. The third question is the one buyers skip.

Why EBITDA is not cash

Affordability is tested on free cash flow. EBITDA is the wrong measure for it. From EBITDA, deduct corporation tax, capital expenditure, the working capital the business absorbs as it grows or as its cycle turns, interest and scheduled debt repayments. Then add the acquisition payments on their dates. In project led businesses the working capital line can swing by more than annual profit: an experiential agency collects deposits before events and pays suppliers after, so its cash balance looks strong in the months before a season and thin in the months after. Measure the cycle monthly before you rely on it.

A worked example: acquiring an experiential agency

The figures are hypothetical. They do not represent lending terms, market multiples or payment norms; the interest rate and tax rate are assumptions chosen for the illustration. A group is buying an experiential agency with normalised EBITDA of £800,000. The price is an enterprise value of £4.0 million on a cash-free, debt-free basis with no working capital adjustment, paid as £2.2 million at completion, £0.9 million of fixed deferred consideration in two instalments of £450,000 at 12 and 24 months, and an earnout of up to £0.9 million, measured annually on gross profit over two years and paid at months 15 and 27 once each year’s accounts are agreed. The target holds £600,000 of cash at completion, of which £450,000 is client deposits against events not yet delivered; its cash is excluded from the funding sources.

The deferred consideration, the earnout and the retention bonuses (£100,000 payable at month 12) do not appear at completion. They appear in the time phased assessment, which is where affordability is tested.

Even in the base case, where the business performs and the earnout is earned, the acquisition consumes about £1.0 million more cash over two years than the acquired business generates. The £300,000 reserve covers part of year one; the rest has to come from the group’s other cash flows or further funding. The greatest pressure falls between months 12 and 15, when the first deferred instalment, the retention bonuses, the loan payment and the first earnout fall due within a single quarter, and again at month 24 to 27. A buyer who sees that in advance can negotiate the dates; a buyer who does not meets it as a crisis.

The downside shows the character of the risk. The earnout falls away, so the maximum total is never paid, and the fixed obligations do not move at all. Weaker trading, slower collections and no earnout leave a cumulative gap of about £1.1 million against a £300,000 reserve, with loan covenants tested on the same weaker figures. The question for the buyer is whether the rest of the group can carry that, and for how long, before the acquisition starts to damage the business that bought it.

Reading the result

The example suggests three responses, any of which might be right. Negotiate the dates: moving the second deferred instalment or the earnout payment away from the loan repayment date reduces the peak. Change the mix: more consideration in shares of the buyer, or a smaller fixed deferred element with a larger earnout, lowers the fixed obligations at the cost of a different negotiation with the seller. Or accept that the deal needs a larger reserve or more equity funding, and decide whether that is still a deal worth doing. What the example argues against is funding a deal to the completion payment and trusting the rest to trading.

What to do next

Build the sources and uses and the time phased schedule before you make an offer, with the target’s monthly cash cycle inside it, and run the downside. If the schedule works only in the base case, the structure or the price has to change. Our buy an agency page describes how we support buyers from strategy and origination through underwriting, structure and completion.

Written by Rick Palmer and Rob Reid, founding partners of Motion Advisory Partners. General guidance, not advice on any specific business or transaction. Legal and tax points vary by jurisdiction and should be checked with appropriate advisors.