Choosing how you finance an acquisition is a vital part of the transactional process. The financing option that you select can have a major impact on the cash flows available to shareholders post-transaction, and accordingly, care should be taken in selecting a financing option that best suits your circumstances.
Below we discuss three broad ways in which you can finance a company acquisition. Each has its own pluses and minuses.
This is where shares in the acquirer’s company are issued to the shareholders of the company being sold.
Structuring a deal in this fashion means that both buyer and seller will share risks post-transaction. For an acquirer this is generally seen as a positive outcome.
One of the downfalls of exchanging stock is that there is now one more thing to negotiate and agree on in the transaction – the value of shares in the acquirer’s company. It is important to engage the services of a company valuation expert to advise on a suitable fair market value.
Further, for shareholders of the selling company, structuring a transaction this way means that should they wish to divest their shareholding in the acquirer company in the future, they will need to find a willing buyer, who is happy to pay a suitable price for a less than 100% holding in the company. For medium-sized companies this could prove difficult.
Arguably, cash is the simplest way to finance an acquisition. When financing with cash, the acquirer simply purchases shares in the selling company off the current shareholders.
When buying with cash, acquirers should ensure they have suitable cash reserves left over after paying for the shares for any working capital required post-deal.
There are numerous ways in which debt can be used to finance a transaction:
Agreeing to take on debt owed by the seller: Many companies look at selling their business due to high debts. Sometimes unfavourable interest rates or poor business trading conditions make it difficult for companies to service their debt. Accordingly, they may look to sell or enter into another form of transaction in order to help the company survive.
In circumstances where company debts are high, an acquirer may offer to take over the selling company by taking over their debts, or potentially taking over their debts and paying a reduced amount of cash on top.
Taking on debt is certainly not a frequently used method for financing acquisitions, however is often worth considering in conjunction with other financing options.
Bank Loans: Bank loans are a common way in which acquirers will look to find transactions. When considering bank loans, it is important to consider the current level of interest rates, and the risk of interest rates increasing over the term of the loan.
From a seller’s perspective, when an acquirer sources their funds through bank borrowing, it normally sees the sellers paid in cash for their shares. This is something that most sellers are quite comfortable with.
Vendor Loans: This occurs when the sellers enter into a loan agreement with the acquirers. Typically these loan agreements will include a commercial rate of interest (or higher), and some form of security for the lender (who in this circumstance, is the selling shareholders).
When structuring a transaction in this way, the sellers still have ‘skin in the game’ post-deal, as they play the role of a lender. Sellers need to be conscious of the acquirer’s likely ability to service the loan post-transaction, and take this into consideration when setting transaction and loan terms. Many acquirers will favour transactions structured in this way, as it can indicate that the sellers are confident of the future trading performance of the company post deal.
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If you are seeking a professional advisor to assist you with the merger, acquisition, divestment or valuation of a business with an enterprise value of between $1 million and $50 million please contact Quinn M&A on 02 9223 9166 or email [email protected] to find our nearest office.