Acquisition Financing

Acquisition Financing
See also

Acquisition Financing is a type of capital that an acquirer obtains with the object of buying another company. It allows the purchase of a target business due to providing resources that can be used in the transaction. Acquiring companies usually have the option to finance all or part of a project through internally generated funds or external sources of funds [1].

Types of financing

An acquisition can be financed by, among others, following ways:

  • Company's own funds is rarely used individually, usually in combination with seller financing and/or a debt financing.
  • Seller financing (also known as 'owner financing' or 'owner carry back') may be an option available in the case of an acquisition if the parent company is willing to hold securities issued by the buying company, such as bonds, promissory notes, and mortgages. This is a highly important source of financing and one way to 'close the gap' between what seller wants and a buyer is willing to pay on the purchase price[2]. Many businesses do not want to use seller financing because it requires that they accept the risk that the note will not be repaid. Such financing is necessary, though, when bank financing is not an option.
  • Bank Loan - the largest source of secured and unsecured debt financing for acquisitions are large international commercial banks[3]. This financing ranges from short-term credit to 30-year mortgages and interest rates vary according to security involved.
  • Issuance of Bonds - corporate bonds are a simple, quick way to raise cash from current shareholders or the general public.
  • Individual Investors "Angels" - a high net worth individual who provides financial backing for entrepreneurs. This method could be used in acquisition financing, however, it may be very expensive, as the buyer may have to give up some part of the ownership of the acquired company[4]

Leveraged Buyout - an acquisition financed largely by borrowing of all the stock or assets of a hitherto public company by a small group of investors[5]. Debt financing represents 50% or more of the purchase price. The tangible assets of the firm to be acquired are used as collateral for the loans.

Factors determining financing

According to John E. Triantis, such considerations determine the kind and form of financing an acquisition[6]:

  1. Legal and tax considerations
  2. Credit worthiness of the entity
  3. Ability to use the balance sheet
  4. Adequacy of cash flows
  5. Cost of financing
  6. Expected financing coverage
  7. Third-party guarantees
  8. Nature and project size
  9. Risk allocation
  10. Unilateral and Multilateral support
  11. Nature of agreements
  12. Credit enhancements and insurance
  13. Constraints of financing
  14. Market conditions
  15. Risk appetite

Footnotes

  1. Triantis, J. E. 1999, s. 313
  2. DePamphilis, D. 2010, s.204
  3. Triantis, J. E. 1999, s. 315
  4. DePamphilis, D. 2010, s.195
  5. Machiraju, H. R. 2007, s.180
  6. Triantis, J. E. 1999, s. 317-318

References

Author: Małgorzata Lasota