Equity contribution, where it comes from and what counts

What a lender means by contribution

Every acquisition lender expects the buyer to put something in, and the reason is simpler than it is usually made to sound. Money that ranks behind the lender absorbs the first losses. If the business underperforms, the value that disappears is the buyer's before it is the lender's. That is the entire function of a contribution, and it explains everything about which forms count and which do not.

There is a second reason and it is not decorative. A buyer with real money in the deal behaves differently from one who has none. Lenders talk about this as commitment, and they mean something specific: someone who stands to lose their own capital manages the first difficult year differently from someone whose downside is walking away.

How much is expected is not a fixed number and it is not published anywhere. It moves with the sector, the quality of the earnings, the buyer's experience, the structure of the rest of the deal and the individual lender's credit policy at the time. Anyone quoting you a universal figure is describing their own habits rather than the market. What can be described accurately is what counts, what does not, and what has to be evidenced.

Where the money actually comes from

In practice a buyer's contribution is rarely one source. It is assembled, and the components look like this.

Cash savings and investments. The simplest and the strongest, because it is unambiguous, it is liquid and its source is easy to evidence.
Equity released from property. Very common, and it changes the risk picture: the borrowing now sits against a home as well as against the business. Where the release is a further advance on a residential mortgage, the lender funding the acquisition will want to know about it, because it is a commitment against the same person.
Cash or borrowing from an existing trading business. Where the buyer already runs a company, its surplus cash or its own borrowing capacity can fund the contribution. This is the strongest position in the market for a bolt-on acquisition, because there is a trading history behind the money.
Rolled equity from a management team. In a buy-out, existing managers who own shares can reinvest rather than take cash out. It costs them nothing on the day and it counts, which is one reason a management buy-out often funds more comfortably than an equivalent purchase by an outsider.
Money left in by the seller. Where it is properly ranked behind the senior facility, some lenders will treat a vendor deferral as part of the buyer's stake. Some will not. The drafting decides it, and the detail is in vendor finance.
Third-party equity. An investor, a family member or a business partner taking shares. It solves the contribution and it costs ownership, which is a different trade and is set out in equity and private equity.

What a lender will not count

The exclusions are more useful than the inclusions, because this is where buyers are surprised.

Borrowed money that ranks alongside or ahead of the lender. An unsecured personal loan taken out to fund the contribution is not contribution. It is another creditor with its own repayment schedule, drawing on the same person and often on the same cash. Lenders ask about this directly, and answering it inaccurately is a serious problem rather than an embarrassing one.

Money that is not yet yours. An expected inheritance, a bonus not yet paid, the proceeds of a sale that has not completed, or funds that arrive only if something else happens first. A lender will fund against money that is in place, not money that is anticipated.

Value rather than cash. Buyers sometimes offer their own time, their customer list, their reputation or the value they intend to add as a substitute for capital. None of it absorbs a loss, so none of it does the job a contribution does.

The target's own money. Using the assets or cash of the company being bought to fund its own purchase raises specific legal issues that a solicitor has to deal with properly. It is not a shortcut and it is not something to arrange informally.

How the source is evidenced

Expect to prove where the money came from, in detail, and expect it to take longer than you think. This is not scepticism about the buyer. Lenders are obliged to establish the source of funds, and an incomplete answer stalls a file more often than a weak business case does.

Bank statements covering a meaningful period, showing the funds in place rather than a single closing balance.
Where the money came from a property, the mortgage offer or the completion statement.
Where it came from another company, board approval and the accounts showing the company can afford it.
Where it came from a family member, whether it is a gift or a loan, and if a loan, on what terms and ranking where.
Where it came from an investment sale, the disposal documentation.

Assembling this before anyone asks is the cheapest time saving available in an acquisition, and it costs nothing but a morning.

Contribution and personal guarantees are not the same thing

Buyers routinely conflate the two, and they do different jobs. The contribution is money that goes in at completion and is at risk from day one. A personal guarantee is a promise that can be called on later if the business does not repay.

A larger contribution can sometimes reduce the guarantee a lender asks for, because the lender is exposed to less of the price. It does not remove it as a matter of course. What a guarantee looks like in practice, whether it is capped, and what supports it are covered in personal guarantees explained, and they are worth understanding before the term sheet stage rather than after it.

What contribution does to the rest of the structure

More contribution is not only about getting to yes. It changes the shape of the whole deal.

It reduces the senior term debt required, which lowers the monthly repayment and gives the business more room to absorb a bad quarter. It reduces the pressure to fill a gap with something expensive, which is the argument made honestly in mezzanine in an SME context. And it tends to improve the terms available, because a lender advancing less against the same earnings is taking less risk.

There is a limit to that logic, and it is worth stating. A buyer who puts in everything they have, leaving nothing behind for the first difficult quarter, has strengthened the credit paper and weakened the business. Retaining a reserve is not a failure of commitment. Running out of cash in month four is.

Worked exampleTake a buyer choosing between putting in everything they hold and keeping a portion back. The larger contribution lowers the loan and the monthly repayment. The smaller one leaves a reserve that covers an unexpected van replacement, a late-paying customer and a quarter of slower trading without a conversation with anybody. Which is better depends entirely on how predictable the acquired business is, and it is a question worth asking out loud before the money moves. The situation described here is a shape, not a real deal.

Where it sits in the stack

Contribution is the bottom layer. Everything else ranks in front of it: the senior lender first, then any subordinated seller money or commercial subordinated debt, then the shareholders. That order is what makes the contribution do its job, and how the layers are put together and presented is covered in stacking facilities.

In sectors where the value is in recurring relationships rather than in assets, contribution carries more weight than it does in an asset-heavy purchase, because there is less for the lender to fall back on. That is one reason a buyer of an accountancy practice is assessed differently from a buyer of a business with a yard full of plant.

What goes wrong

The contribution was borrowed and nobody said. It emerges in diligence, and what was a funding question becomes a trust question.

It was committed before the deal was tested. Money moved early, into a deposit or an exclusivity payment, is money that is no longer available if the structure has to change.

The source could not be evidenced quickly. A perfectly legitimate contribution held in an account with a complicated history takes weeks to explain, and it holds up everything behind it.

Every last pound went in. A business bought with no reserve behind it is one late payment away from a difficult phone call.

Finding out how yours will be counted

Whether a particular contribution counts, and how much weight it carries against a particular kind of earnings, is a matter of individual credit policy rather than published rule. The same money can be read two ways by two lenders looking at the same deal.

We know this market and we know specific people who fund acquisitions in these sectors, so the useful thing we can do is tell you how your position is likely to be read before you commit any of it. Tell us where the contribution is coming from and what you are buying, and we come back to you having spoken to them.

We introduce buyers who are acquiring through a limited company or a NewCo. If you are buying personally, as a sole trader or as a partnership, we will point you to an authorised firm directly instead.