Acquisition Finance

Acquisition finance refers to the range of funding mechanisms used by a company to finance the purchase of another company. It includes a mix of debt (loans, bonds), equity (new share issuance), and hybrid instruments (convertible notes, mezzanine finance) structured to fund the acquisition price.

What Is Acquisition Finance?

When a company acquires another, it needs to pay the target’s shareholders. The acquiring company must decide how to fund this payment. Common acquisition finance structures include:

– **All-cash deal**: the acquirer uses existing cash reserves or borrows money to pay cash to target shareholders
– **All-stock deal**: the acquirer issues its own new shares to the target’s shareholders in exchange for their shares
– **Cash and stock mix**: combination of cash payment and share exchange
– **Leveraged buyout (LBO)**: the acquirer borrows heavily (often secured against the target’s assets) to finance the acquisition

Types of Acquisition Finance

**Debt financing:**
– Acquisition loan from banks (term loans)
– High-yield bonds (junk bonds) for leveraged buyouts
– Bridge loans (short-term debt repaid after deal closes)

**Equity financing:**
– Issuance of new shares by the acquirer
– Rights issue to raise funds from existing shareholders
– Private placement to institutional investors

**Hybrid instruments:**
– Convertible debentures
– Mezzanine finance (subordinated debt with equity kickers)

Key Considerations

– **Cost of capital**: debt is cheaper but increases financial risk; equity dilutes existing shareholders
– **Target’s cash flows**: a highly cash-generative target can service acquisition debt more easily
– **Deal structure**: all-stock deals avoid debt but may dilute acquirer’s EPS; all-cash deals avoid dilution but increase leverage

Practical Example

An Indian e-commerce company acquires a logistics startup for Rs 3,000 crore. It funds Rs 1,500 crore through a rights issue to existing shareholders, Rs 1,000 crore through a 3-year term loan from its bank, and Rs 500 crore from its own cash reserves. The debt is to be repaid from the logistics company’s cash flows over 3 years.

Key Takeaways

– Acquisition finance is the funding structure used to pay for a corporate acquisition
– Common methods include cash (from reserves or borrowings), stock swaps, and hybrid instruments
– Leveraged buyouts use significant debt secured against the target’s assets
– All-cash deals avoid dilution but increase leverage; all-stock deals dilute but preserve cash
– The right financing mix depends on the acquirer’s balance sheet strength, cost of capital, and target’s cash flow profile