What is M&A Financing?
M&A financing is the process of raising money to fund mergers and acquisitions. The primary sources of M&A financing are equity financing and debt financing. Companies may also use their existing cash reserves.
A key consideration in M&A financing is to ensure the capital provided is sensitive to the company’s operating cash flows. For example, if the company is raising debt financing, it should have adequate coverage to fulfill the interest obligations and eventually repay the debt.
Another aspect of M&A financing is control over the combined organization. Equity financing could lead to a loss of control if the target is a large proportion of the combined company. Depending on their finances and their willingness to exercise control, companies could use any one or a mix of these sources to fund M&A transactions.
Key Learning Points
- M&A financing involves raising funds to finance M&A transactions. Companies may use equity financing, debt financing, or a mix of the two
- M&A financing needs to be sensitive towards the operating cash flows of the combined company. Unlike equity financing, debt financing leads to cash outflows (for interest payments and repayment of the debt)
- Typically, companies incur transaction fees when raising capital. Transaction fees are a use of funds and need to be considered as part of the total cost of the deal.
- As part of equity financing, companies may sell equity shares and raise cash for M&A financing. Alternatively, they can use their stock as consideration instead of cash
- Debt financing is raising debt for M&A financing. In times of low-interest rates, debt is a cheaper source of M&A financing when compared to equity financing
Types of M&A Financing
Equity financing, in the context of M&A financing, can mean two things: 1) The company selling its equity to raise cash to fund the deal, and 2) A stock swap or the company using equity as a currency (instead of cash) to acquire the shares of the target company. A stock swap or the exchange of one company’s equity for another helps the acquirer preserve cash. Those without a lot of cash reserves can save on their borrowing costs. The seller’s shareholders get an opportunity to gain from the future gains of the combined business. Sellers also get to defer tax payments related to any gains on the sale of their shares. On the flip side, equity financing involves issuing new shares, leading to dilution of ownership for existing shareholders.
Debt financing is raising money from lenders on the condition of repaying the borrowed amount later. For startups and less mature companies, debt financing is harder to obtain when compared to equity financing. However, in times of low-interest rates, it is a comparatively cheaper source of funding.
In M&A financing, the amount of debt financing depends on the combined firm’s consolidated debt capacity. It is typically based on an EBITDA multiple (e.g., a Debt/EBITDA of 6x would mean the company can get debt of up to 6 times its EBITDA). The interest rate charged depends on the consolidated risk of the combined entity. Debt financing can adversely affect the borrowing company’s credit ratings.
Example: M&A Financing
Below is some information about the acquisition of Nordstrand Plc.
We have been asked to construct a table detailing the sources and uses of funds.
Debt refinancing refers to the refunding of debt with new debt. The total funds used to finance this M&A transaction are 3,240.
The equity financing of 600 is 30% of the equity purchase price (2,000). Equity financing cannot contribute to 30% of the total sources of funds as debt holders are unlikely to accept shares as debt repayment. Therefore, equity financing can only be used for the deal’s equity portion. The remaining is going to be funded by debt financing.