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If you are interested in buying another business, you can choose to acquire it outright or merge it with your own business. Regardless, paying for a business can be an expensive endeavour. Unless you have sufficient cash lying around, you will probably need to fund the acquisition by drawing on outside funds. This article will explore the different ways you can finance the acquisition of a company.
Acquisition Finance
Acquisition finance refers to raising capital (money) specifically to purchase another business. The parties involved in the purchase of a business (the target) will be the buyer (you or your business) and the seller (the owner of the business you are buying).
Additionally, depending on the finance strategy, it is common to have one or more banks involved in the deal. These banks will lend capital to the buyer or the target company itself.
Transaction Structure
Typically, you can structure a business sale as either a share sale or an asset sale.
In a share sale, the only thing changing hands are the shares in the business’ parent company. In an asset sale, as the buyer, you would choose which assets you wish to acquire. These would then be transferred directly to you or one of your business’ companies. Alternatively, you can create a new company and transfer those assets to it.
Equity Financing
In the context of acquisition financing, equity financing is where the buyer’s shareholders inject additional cash into the business in exchange for additional company shares. The buyer then uses the cash raised by shareholders to acquire the target company, either by purchasing the shares held by the target’s owners (the seller) or the desired assets in the business.
If you own a private company, it is impossible to offer shares for sale to the public. That said, you could feasibly approach your network and invite them to acquire shares in your business. However, you should fully inform them of the risks associated with becoming a shareholder. In practice, they should seek legal advice before buying any shares in your company.
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Debt Financing
Using debt financing means that the borrower (or the target company) borrows money from a third party (a bank) and then uses the borrowed money to pay for the shares or assets, depending on the transaction structure.
For large acquisitions, debt financing can become quite complex. However, in general, you can break debt financing down into borrowing money using:
- pre-existing loans; or
- newly-issued loans.
If you are dealing with non-bank lenders, they may also seek to acquire equity or quasi-equity rights, either in your company or the target company.
Pre-Existing Loans
The simplest example of a pre-existing loan to finance an acquisition would be where the buyer receives a loan from a bank. The buyer takes the loan money and pays for the shares or assets in the target. The buyer then pays back the loan according to its terms.
Bank lenders are unlikely to lend to you without being confident they will receive their money back, regardless of how successful or unsuccessful the acquisition ends up. To do this, they will almost certainly take security over the buyer’s assets. Failure to repay the loan gives the bank the right to take the buyer’s assets and sell them to repay themselves.
Newly-Issued Loans
Newly-issued loans broadly refer to leveraged buy-out situations, which are beyond the scope of this article and more specifically relate to private equity transactions.
Practical Considerations
In practice, most medium and large acquisitions are funded through debt and equity financing. The factors that influence how much debt to equity should be used include:
- the buyer’s access to debt financing;
- the target company’s creditworthiness;
- how much cash the buyer has on hand;
- interest rates; and
- the intention behind the acquisition, specifically the role the acquired business will play in the buyer’s business.
If you need access to debt financing, you should instruct a team comprised of a legal adviser, financial adviser and accountant.
Key Takeaways
Buying another business is complex, time-consuming, and above all, expensive. To finance the acquisition, most buyers either have to raise equity or debt finance. Equity financing is where the buyer issues shares in itself to existing (or new) shareholders in exchange for cash. The buyer (or another group company) then uses the cash to pay the seller. Debt financing is where a lender — usually a bank — loans money to the buyer. This money is then used to pay the seller. In practice, most acquisitions are funded through a mixture of debt and equity.
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Frequently Asked Questions
Acquisition finance refers to how a buyer structures the purchase of another business.
You can fund the purchase through equity financing (issuing shares to existing or new shareholders) or debt financing (borrowing money from a lender). In practice, most buyers will fund the purchase of a business through a mixture of both.
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