Debt Financing of Acquisitions11 September 2019 | 12:28 | Focus News Agency
Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com/), a Central European corporate finance firm, and author of Business Exit Planning (www.businessexitplanningbook.com/).
There are many reasons for using debt to finance an acquisition. Some buyers simply do not have enough cash. Others want to improve their return on equity by using low cost debt (see our earlier article “Optimizing Company Valuation via Cost of Capital”). Still other investors prefer to take advantage of tax write-offs permitted by deductibility of interest costs in most jurisdictions. Quantitative easing has also made debt cheap over the past decade, by historic standards. Debt financing may help avoid the need to raise equity financing, hence dilution of equity and control.
In most cases mid-sized companies have limited access to public capital markets (equity or bonds), hence there may not be that many alternatives to financing an acquisition by bank debt. The following table summarizes some of the basic types of bank debt to finance an acquisition.
Exhibit 1: Types of Bank Debt Finance for Acquisitions1
When an acquiror considers financing options, the potential to raise debt based on assets and cash flow of the target are usually taken into consideration, but the synergies between acquiror and target are sometimes neglected. Years ago, we were representing Hungarian Telephone and Cable Corporation (HTCC) in its acquisition of PanTel, a Central European data communications company, where we constructed a financial model that persuasively demonstrated synergies resulting from the acquisition in excess of EUR 20 million a year. This provided HTCC with the additional cash flow to service the additional acquisition financing, and calculating company valuation at 6x EBITDA, an additional EUR 120 million in valuation. (Care must be taken with synergy analysis, as synergies often prove to be a mirage).
In conclusion: debt financing is a flexible and relatively low-cost option for financing acquisitions, particularly in today’s competitive and liquid market environment. However, leverage is a significant risk which may contribute to or cause business failure, especially during recessions or financial crises. An acquiring firm’s financing decision should be strongly influenced by its debt capacity, existing leverage and target leverage ratio—in short, on shareholders’ appetite for risk versus reward. A balance must be struck.
1. Created by authors with data from M&A Trending Trends in Debt Financing by Alison Manzer
© 2019 All rights reserved. Citing Focus Information Agency is mandatory!
All opinions, assessments, and statements, expressed in interviews, are personal and Focus Information Agency bears no responsibility for them.