This article is written by Sunandeni R, pursuing a diploma in intellectual property, media and entertainment laws from LawSikho.
Acquisition finance as the name signifies is the financing of capital for the purpose of Acquisition proceedings. While buying a business be an asset or any other related process related to the business the acquirer has to have specific funding for achieving the same. For instance, a small or mid-size business may plan to acquire a bigger business to scale up the services and thereby increase the operations multifold which requires appropriate and high funding. Primarily, loans from Bank, credit, loans from private sources are some of the forms of Acquisition Finance. Let’s look at what are the different types of Acquisition finance.
Types of Acquisition Finance
- Stock Swap Transaction
- Acquisition through Equity
- Cash Acquisition
- Acquisition through Debt
- Acquisition through Mezzanine or Quasi Debt
- Leveraged Buyout
- Modelling Acquisition Financing
- Seller’s Financing / Vendor Take-Back Loan (VTB)
Now let’s look at each one of them individually:
Stock Swap Transaction
Stock swap Transaction: Most popular and commonest of all is the stock exchange type of acquisition finance wherein an acquiring company transfers its stock with the Seller’s company in exchange of shares and other fixed beneficiaries. This kind of financing is safe in terms of risk-sharing equally both upon the acquiring company and seller company. Diligent evaluation of the stock in the Seller companies and subsequent comparative analysis of the company is making crux of the stock-swap transaction.
Acquisition through Equity
To offer equity shares to the desiring owners of an acquiring firm/company is the one of the best and run through processes while making a business transfer, in specific while the acquiring company desires to take hold of the seller/merger company. It is more often two different companies come together to be branded as one single company or either small-sized company merges with the large company wherein the larger one transfers some of its equity for the said acquisition with less or no utilization of cash for the said transaction as part or whole.
Whatever be the case, the benefit is all about the use of less/no cash and retaining some of the seller’s proficiency and insight, to make a company equity an influential acquisition in terms of funding as well as the operations.
The nature of acquisition herein is done all through cash. Wherein if an acquirer company buys a legal entity it becomes the legal owner of all the assets, liabilities, and business operations related to the seller company on a wholesale basis. This type of acquisition is known as risk and reward form of acquisition wherein the risk is the arrangement of lump sum cash for the said business transfer and reward is the acquisition in itself. In this type of acquisition, the transition of ownership is clear and precise. Some of the examples of Amazon acquisition of whole foods and Sun Pharmaceuticals acquisition of Ranbaxy.
Acquisition through Debt
This type of acquisition is the one of low cost and alternative to paying cash or stock in lieu of recurring debt by the Seller Company. Herein the Seller company is unable to make payments and thus debt acquisition is a mutually beneficial method wherein the for seller company debt is financed and the acquirer company acquires business contacts, property and shares as part of the debt acquisition.
Acquisition through Mezzanine or Quasi Debt
The nature of acquisition here is a combination of debt acquisition and stock swap acquisition. Here the acquirer company is vested with rights to convert to an equity interest in instances of any default. The arrangement of financing leads to raising funds and expects reliable returns comparative to other forms of acquisition. Mezzanine financing gives the investors the best rate of return with its interest payments and borrowers prefer this as its interest is tax-deductible.
Quasi debt is a flow of cash rendered for repayment of the loan or debt of the seller company and the same is agreed to recur via future cash flow earned out of the business. The usual term agreed upon for the said process is a minimum of 5 years.
The acquisition of a firm or company be it privately held or publicly through a significant amount of borrowed funds by an independent acquirer who is in the business is called the Leveraged Buyout. Such acquisition when synced with a private equity firm who will be an official financial sponsor or in case a group of private equity firms come together to help the independent acquirer in the acquisition is termed as a consortium. The purchase of the assets and liabilities in such acquisition comes from a combination of capital both from the individual contributor or financial sponsor/consortium. By the time purchase is complete the debt and equity ratio is almost balanced up to 60 to 80 percent of the debt.
Following are the characteristics of a leveraged buyout:
- Seller company to be from an industry that is established and stable.
- A balance sheet that is clean with low or no outstanding loan or debts.
- Potential business improvement course.
- Strong market position.
- The possible sale of non-performing or non-core assets of the seller company.
- Healthy capital structure.
Some of the famous leveraged buyouts are:
- Energy Future Holdings
- Hilton Hotel
- Clear Channel
- PetSmart Inc.
- First Data Corporation
- Freescale Semiconductor, Inc.
Seller’s Financing/ Vendor Take-Back Loan (VTB)
Seller’s financing is simple terms is known as vendor take-back loan wherein a seller who has mortgaged his property with a bank seeks a loan in lieu of selling the mortgaged property. This type of acquisition can occur in different forms while deals can range from 80% of the mortgaged property value using traditional banking methods for financing. In layman’s words, the seller is providing a second mortgage loan to minimize the agreed up acquisition deal amount, i.e. using the financing on a property up to 80% of the loan to value when a bank would only loan 65%.
Benefits of Seller’s financing:
- When the markets are slow it helps in fast conclusion and sale of property/assets.
- Most of the investors are willing to purchase property-backed with bank financing in place such as this.
- The principal benefit herein for a seller is to gain high returns upon the sale proceeds and set down the funds with the bank.
Modelling Acquisition Financing
Microsoft Excel has made math more organised and structured to match the growing needs of business across of industries and financial modelling one such feat that a spreadsheet in MS Excel does that it forecasts the growth rate, periodical performance, history and statements, balance sheets, cash inflow and out the flow of a given company. There are various types of a financial model to match every business need and requirement. Some of the very known models include:
- The discounted cash flow model
- Leveraged Buyout model (explained above)
- Mergers and Acquisitions.
Professionals that rely on such models include investment bankers, equity research associates, corporate firms, due diligence and valuation teams.
Most famous and frequently used financial models include:
- Three Statement Model
- Discounted Cash Flow (DCF) Model
- Merger Model (M&A)
- Initial Public Offering (IPO) Model
- Leveraged Buyout (LBO) Model
- Some of the Parts Model
- Consolidation Model
- Budget Model
- Forecasting Model
- Option Pricing Model
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