How Vendor Due Diligence Impacts Acquisition Financing Terms

Acquisition financing lenders rely heavily on cash flow stability in their underwriting approach. Providers of acquisition financing capital assume that historical performance is reflective of future levels of cash flow.

This underwriting philosophy holds as long as there is working capital equilibrium on a post-closing basis, where historical working capital ratios remain intact. Vendor due diligence enables acquisition financing providers to test this assumption and make any adjustments needed to their term sheets.

Vendors usually have good visibility as to the operational and competitive strength of their customers. They also have a standard credit limit for each customer based on size and payment history.

Vendor due diligence allows lenders to gain comfort on working capital stability prior to making the loan. Through talking to the vendor, the acquisition financing lender can gauge their view of the creditworthiness of the borrower and the risk of their credit terms.

Vendor Due Diligence in Acquisition Financing

Sometimes the borrower is not fully aware of how good their credit terms are or how large a line their vendors extend. Not all credit terms are based on number crunching, as vendors will often favor certain customers given the quality of the relationship.

The vendor may be comfortable with 45 days, if the customer is underleveraged. Once acquisition financing occurs and the company is fully leveraged, the vendor may get worried and decide that 45 days is too high and want payment in 30 days.

This accelerates accounts payable outflow at a time when debt service has increased and rapidly erodes the liquidity of the company. Smart acquisition financing lenders sleuth out the probability of this happening up front and ensure their facility contains adequate working capital support.

Additionally, too much vendor concentration also poses a risk that the company is over-reliant with its suppliers. This creates operational risk that the acquisition financing lender’s structure around through lowering the leverage multiple and increasing their interest rate spread.

Vendor due diligence is critical for all acquisition financing providers to ensure that past is prologue with respect to working capital trends.