“How Much Debt to take when Building a HoldCo”
If you are building a HoldCo, follow this rule when taking on debt.
We took on too much leverage for our first acquisition. We had little capital and lots of naivete, so we financed the deal with 90% leverage. There were lots of ways that deal could have gone bad, luckily for us, it did not. From then on this is how we decided how much debt to take on:
We took on as much as our existing operations could comfortably pay back.
We factored $0 from our new acquisition, the one we were financing, when deciding how much company we could afford and how much leverage to take.
This way even if the most recent deal was a total bust, we would survive. Sure, we would waste a bunch of years paying back the loan. But we would survive.
So, if my current HoldCo makes $300,000 of cash flow per year, how much debt can I comfortably take on? At an 8% interest rate and 5-year payback, I would say $900,000 of debt is the max. Easy math has you covering interest payments and paying back the loan within 4 years.
If you look to acquire a new company earning $400,000 for $1,600,000, you will need to have a little over 2 years of retained earnings ($700,000) saved up to proceed.
This may be a bit slower than some want to move. It may not be aggressive enough for others. But you have taken all the pressure off the new acquisition. If it only earns $200,000, you are fine. If it earns $0, you are fine. If it earns anywhere near the $400,000 expected, you will pay back the loan in under 2 years and start stacking capital again.
Then for the third acquisition, you run the same analysis looking at your two company HoldCo. Each time you grow taking on a reasonable amount of debt, not needing the most recent deal to be a home run, and sleeping well at night.