Acquisition finance represents a type of debt investment that is provided by economic institutions or others sponsors to purchase commerce. Such a solution is allowed when the customer is not able to fully defray for a bargain from existing reserves. At the same time, a client can act as an existing company or a targeted start-up.
Types of a deal which involve acquisition finance include a buyout of leading firms, management fees, borrowed funds, and general corporate goods. A core element of acquisition finance is subordination. In this context, a hierarchy is carefully prescribed in treaties between business partners. Of course, it is not superfluous to consult a lawyer.
Two Main Sources of Funding for Acquisition Finance
Trade acquisitions are supplied with material resources from a variety of channels. Choosing the right investor, evaluate the cost of attracting his/her capital, interest rates, a flexibility of the payment system and dividends, which he or she expects in the future.
Among the most popular options, experts note equity and debt financing. Most firms prefer to include a promissory element in their capital structure since interest on loans is not taxed. In addition, it facilitates diversification of potential creditors, for whom liability is an attractive clause for cooperation because of the minimal risk of losing business.
The less preferable way is the financing of assets, in which shares of the acquired enterprise or its intellectual property are offered as collateral. Customers who focus on firms in unstable industries and with free cash flow elect this option. It provides more flexibility due to the lack of obligations for paying of planned payoffs. In such case, equity trustees take over part of the property or introduce their representatives to the board of directors.
As a rule, remuneration of cash is not a strong point of numerous companies, because their budget is in constant turnover. Bank employees in detail analyze the projected cash flow, both the target firm and an acquirer. An akin method is one of the most sought-after forms of acquisition finance facilities because of low cost and tax benefits. The rate of return is from 4% to 8%.
The total liability package consists of the number of credits. Experts identify common types of debt.
- Senior one includes most of the part, namely: direct sponsorship of an acquisition and a set of working capital. Such loan is provided by one or several banks and is perceived as a priority.
- Junior debt is usually used as a “supplement” to the main sum. It plays a vital role in ensuring the purchasing process. In recent years, buyers are increasingly interested in obtaining part of an investment. This is due to his/her unwillingness or inability to pay the full cost of the products upon completion of the transaction.
The mentioned procedure may take various forms to depend on the structure of the future acquisition. For instance, a public or private company is able to buy an entire block of stocks or a part of it by issuing its own assets. Similarly, a merger can be financed in whole or in part from own resources or securities.
The value of shares is subject to fluctuations, so the purchase price is less predictable than the net cash transaction. In addition, shareholders of the acquired firm are entitled to participate in the meetings. This may affect the capital scheme and performance monitoring. But, on the other hand, equity contribution encourages a shareholder to remain involved in the process, despite the change in ownership.
Quite often private funds are allocated from personal equity sources. Borrowers may demand a percentage of a total sum. The rate will vary hinging on the risk profile of a target company in the range from 20% to 35%. It is worth noting that the greater the share of total financing for the acquisition, the lower the risk of fraud. Public and private firms may also consider using preference shares as consideration for the purchase.
High Yield Bonds
It means giving loans to finance attainment of companies or parts of it by an existing internal, external management team or a third party. This method covers firms with an unusually high degree of debt.
Such an event is considered quite risky and costly. The funds attracted are usually used to achieve specific temporary aims, such as the repurchase of shares or payment of single dividends. Similar financing provides for two main forms: loans and high-yield bonds. The former is rated at a higher level than obligations with a rating below the “investment grade”.
The dominant tool in most financed borrowed funds is “intermediate” debt. It has long been used by medium-sized firms in Europe and the US as an alternative to bank credit. Mezzanine investors tend to take higher risks than bond buyers but receive a reward of 10 to 20 percent.
Small-scale companies have become traditional users of the described way. In addition, it is increasingly prescribed in the package of sponsorship for larger transactions. Cheap coupons combined with yield make hybrid loan an excellent clipboard between senior creditors and investors.
Thus, acquisition finance offers different alternatives to achieving the purposes. They range from secured bank loans to subordinated bonds. The role of leading financiers is to correctly understand and show an essence of each type of finance. If they overvalue the company's ability to repay the debt, the latter can end with crushing bankruptcy. If the meaningless of the firm is underestimated, a transaction may be lost. Before you make a final decision, weigh all the pros and cons.