Debt a means of funding an acquisition
- (14/1/2004) Previous PageDebt for corporate deals
If you're planning to acquire some or all of the issued share capital in an established business, you will almost certainly need to raise substantial funding. As well as the assets of the business to be purchased, you will also assume responsibility for all of its financial liabilities. These will almost invariably include business borrowings of one kind or another. As part of the transaction, you will have to reorganise the shareholdings and restructure the entire funding of the business. Although the existing shareholders may wish to retain an interest, the ownership of the majority interest will generally be divided between the new management and the providers of risk capital or private equity, usually a venture capitalist.
Debt structureSome of the business's borrowing may be in the form of loans and mortgages. These are relatively easy to quantify and transfer because they are secured against assets such as property and equipment. Existing financial arrangements covering such assets are sometimes simply left in place as part of a deal. Considerable expertise and flexibility are needed to restructure the business's debts to release maximum value to the vendors and provide enough funding for the business to continue. All manner of issues need to be considered, such as foreign exchange rates; tax liabilities; legal and employment issues, insurance and incomplete contracts. Once an equity provider has provisionally committed itself to an acquisition, a bank will provide the balance of funds needed to complete the deal and fund the day-to-day running of the business. The same bank will also usually take care of debt restructuring. The bank will usually provide a combination of senior debt and working capital facilities, which represent secured advances. Sometimes, mezzanine finance may be required. You need to understand the differences between these three forms of debt:
Senior debtA bank providing senior debt will, as the name suggests, have priority in any claim on the security provided. When a syndicate of banks is funding the acquisition, priority may well be shared but one bank will act as the prime interface between the company and the syndicate of bankers.Broadly speaking, senior debt will be secured by fixed and quantifiable assets, including land, offices, factories, shops and salesrooms. The purchasers borrow cash against the value of these assets to acquire the business.
Working capitalWorking capital to run the business is advanced to accommodate short-term cash flow requirements arising from the normal purchase and sales cycles.
Mezzanine financeMezzanine finance is a secondary tier of debt - hence the name - which falls somewhere between risk capital and secure debt. It is provided alongside the senior debt, where a somewhat higher level of risk is accepted in return for a higher rate of interest. It can be seen as a more expensive "top up" when the gap between equity and senior debt needs to be bridged. Because it carries higher risk, mezzanine finance may rank behind senior debt in default priority.
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