The Importance of a Strong Balance Sheet For M&A

By: Mike Ertel
Managing Director
Transworld M&A Advisors

Most M&A experts agree that the ultimate transaction value of any profitable, on-going business is largely determined/ influenced by its cash flow, which is most frequently expressed as its adjusted, or normalized, earnings before interest, taxes, depreciation and amortization (EBITDA).  If that’s the case, why should we be at all concerned about the strength of the company’s balance sheet?

In point of fact, the role of the company’s balance sheet in the M&A valuation process is not well understood – even by many M&A professionals.  Recognizing that in almost all cases the buyer will need to re-engineer the company’s debt in order to finance the acquisition, many M&A advisors spend little time analyzing the seller’s balance sheet.

In reality, the strength of the company’s balance sheet, particularly as it relates to the collateral value of the company’s assets, plays an important role in determining just how much bank debt the business will support, which in turn affects how much cash equity the buyer will have to invest to finance a particular purchase price.  Since bank debt typically has a much, much lower return expectation (interest rate) than equity, a company with a strong balance sheet can typically command a much higher purchase price, and still meet the buyer’s expectations for the return on his equity investment.