Finance



Financing M&A

Financing an M&A transaction isn’t a matter of currency transfer.

Mergers are generally differentiated from acquisitions partly by the way in which they are financed and partly by the relative size of the companies and transactions. Various methods of financing an M&A transaction exist and are not limited to those below:

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Cash

Payment by cash.

Such transactions are usually termed acquisitions rather than mergers, because the shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidder’s shareholders.

Stock

Payment in the form of the acquiring company’s stock, issued to the shareholders of the acquired company at a given ratio proportional to the valuation of the latter. They receive stock in the company that is purchasing the smaller company.

Financing options

There are some elements to think about when choosing the form of payment. When submitting an offer, the acquiring firm should consider other potential bidders and think strategically. The form of payment might be decisive for the seller. With pure cash deals, there is no doubt on the real value of the bid (without considering an eventual earn-out). The contingency of the share payment is indeed removed. Thus, a cash offer pre-empts competitors better than securities. Taxes are a second element to consider and should be evaluated with the counsel of competent tax and accounting advisers. Third, with a share deal, the buyer’s capital structure might be affected and the control of the buyer modified. If the issuance of shares is necessary, shareholders of the acquiring company might prevent such capital increase at the general meeting of shareholders. The risk is removed with a cash transaction. Then, the balance sheet of the buyer will be modified and the decision maker should take into account the effects on the reported financial results. For example, in a pure cash deal (financed from the company’s current account), liquidity ratios might decrease. On the other hand, in a pure stock for stock transaction (financed from the issuance of new shares), the company might show lower profitability ratios (e.g. ROA). However, economic dilution must prevail towards accounting dilution when making the choice. The form of payment and financing options are tightly linked. If the buyer pays cash, there are three main financing options:

  • Cash on hand: it consumes financial slack (excess cash or unused debt capacity) and may decrease debt rating. There are no major transaction costs.
  • Issue of debt: it consumes financial slack, may decrease debt rating and increase cost of debt. Transaction costs include underwriting or closing costs of 1% to 3% of the face value.
  • Issue of stock: it increases financial slack, may improve debt rating and reduce cost of debt. Transaction costs include fees for preparation of a proxy statement, an extraordinary shareholder meeting and registration.

If the buyer pays with stock, the financing possibilities are:

  • Issue of stock (same effects and transaction costs as described above).
  • Shares in treasury: it increases financial slack (if they don’t have to be repurchased on the market), may improve debt rating and reduce cost of debt. Transaction costs include brokerage fees if shares are repurchased in the market, otherwise there are no major costs.

In general, stock will create financial flexibility. Transaction costs must also be considered but tend to affect the payment decision more for larger transactions. Finally, paying cash or with shares is a way to signal value to the other party, e.g.: buyers tend to offer stock when they believe their shares are overvalued and cash when undervalued.

Parties should also consider their accounting treatment of M&A transaction costs and ensure they comply with Department of Treasury regulations, including the applicability of the “end of the day” and “next day” rules.

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