Acquisition Financing

Acquisition Financing
See also
External sources of finance Direct paper Source of financing Interim financing Long-term financing Credit Facility Equity instrument Eurocommercial Paper Long-term debt Funding agency

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 .

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. 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. 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

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. 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:

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

References

• Amorim, D.P. (2016). Financing Acquisitions and Growth: The Ambev Case, "Revista de Negócios", 21 (3/4)
• DePamphilis, D. (2010). Mergers and Acquisitions Basics: All You Need To Know, Academic Press
• Fischer, M. (2017). The source of financing in mergers and acquisitions, "Quarterly Review of Economics and Finance", 65
• Machiraju, H. R. (2007). Mergers, Acquisitions and Takeovers, New Age International
• Triantis, J. E. (1999). Creating Successful Acquisition and Joint Venture Projects: A Process and Team Approach, Greenwood Publishing Group

Author: Małgorzata Lasota