Acquisition Finance is mobilising capital or funds to complete the acquisition of a company by another company. It is the process of obtaining capital set aside for a particular acquisition or for the acquisition purpose in general for companies that regularly undertake acquisitions.
Acquisition finance can take several different forms including Debt, Equity, or some form of Hybrid instrument.
Acquisition financing is rarely procured from one source. Several available financing alternatives are weighed, and an appropriate mix of financing is selected that offers the lowest cost of capital to the acquirer. Further, it gives the acquirer an incentive to go for only those targets which can lead to a positive Net Present Value.
Acquisition financing options available to an acquirer will typically be situation-specific and will depend on, among other things, the acquirer’s current balance sheet, the amount of financing required, the nature of the business being acquired and whether the acquirer is willing to give up an ownership stake.
Companies can derive multiple benefits from acquiring other companies, such as business synergies, economies of scale and increased market share.
Acquisition Finance Options:
1.Own funds of Acquirer
If the acquirer has enough surplus cash with no other alternative usage of the cash; acquirer can utilise 100% of own funds to fully finance the acquisition. However, self-funding on a full basis is a rare option unless the acquisition value is not significant vis a vis the size of the acquirer.
Acquirers’ own equity is offered as a consideration to finance the acquisition. This option dilutes the equity interest of the owners of the acquirer. Equity being most expensive form of capital; this option is used if mobilising debt is less probable.
If the Acquirer as well as Target are publicly listed companies; share swap could finance the acquisition whereby the owners of the target receive shares of the merged company. This financing option could be used to facilitate the owners of Target to remain involved in the business of merged company.
4.Acquisition financed by Bank Debt
Financing acquisitions by debt is the most common option; debt being the least expensive form of capital. Mobilising Bank Debt but will be dependent on the acquirer (or the target) having assets that can be used as collateral as well as the acquirer’s ability to demonstrate that it will have sufficient cash flows to service the loan.
5.Acquisition financed by Mezzanine Finance
Acquirer could use Mezzanine Finance to fund an acquisition. Mezzanine finance is expensive in comparison to Bank finance., hence, Mezzanine finance is usually used by acquirers in combination and in addition to the bank finance. If the total debt financing requirement is more than the ability of banks to extend financing, mezzanine finance is moblilised. Mezzanine lenders are more focused on the acquirer’s ability to service the debt based on future cash flow and are less reliant on the acquirer providing collateral.
6.Acquisition financed by Bond/Sukuk issuance
Acquirer could mobilise funds from capital market by way of Bonds or Sukuk, which is a separate pool of liquidity available to companies. Mobilising funds by this option preserve the existing banking limits of acquirer. Bonds/Sukuk do not amortise and have a bullet repayment structure which provides acquirer with the desired flexibility to manage its cash flow. However, mobilising funds thru capital market could take a longer time.
7.Leverage Buy Out
Financing option that uses high leverage and marginal equity to finance an acquisition. Aacquirer in a leveraged buyout, typically a private equity firm, will use its assets as leverage. The assets and cash flows of the Target are also used as collateral for the financing. Acquirers like leveraged buyouts as they put marginal equity resulting in a high Internal Rate of Return.
8.Private Equity firms
Acquirer could join hands with Private Equity firms for the acquisitions. In this option, the PE firms take a stake in the Target along with the acquirer. The PE firms are also involved in management decisions of the Target.