Say I have a hypothetical M&A deal I'm advising on, and I need to consider the financing option for this deal to go through. If I have a fully financed debt option, an equity option, or an equal mixture of the two (and I've chosen this third option), what factors do I need to consider before making this decision?
So like, if I've already gone ahead with an equal split of both debt and equity, what reasons could I state for arriving at this option? Any company specific factors I should be looking at? Or maybe some macroeconomic issues such as interest rates and/or stock volatility?
Thanks guys appreciate the help.
Wait did you build a model with assumptions and projections of synergies?
Yeah I did. There's revenue and cost synergies to be had, but I just wanted to approach this particular question from a qualitative standpoint instead of it being model-driven. Or am I mistaken, and the only way to justify my split of debt and equity is through these synergies I've modeled out?
Is this an exam question or a real life thing? Why is it hypothetical?
I'm building an M&A case study for practice purposes. I'm starting an M&A gig in a few months and I've got some time off so figured would be good to get some practice. Created a hypothetical model with imaginary targets.
Have you thought about explaining your capital structure in terms of earnings or solvency of the combined entity?
Is this your first M&A exercise?
Appreciate your help man. How would I go about explaining it from the capital structure side of things? And yes, first attempt at an M&A exercise (so forgive me for being a bit naive).
To branch of the above point. An all equity portion doesn't allow for the tax shield which can be recognized with debt applied to the business. An all debt financing would make the tax benefit worthless because the amount of leverage would make the debt portion very expensive, and a high interest rate. An equal mixture of the two may be the optimal capital structure for the company. Hope this helps.
Thanks man, this is more of the type of answer I was looking for. Would an equal mixture qualify as being a leveraged buyout? I know traditionally more debt is used, but would it also qualify as an LBO?
No. Think of a mortgage which may be the simplest form of a leveraged buyout. The house is 500k and you pay 100k outright (20% or your equity portion). The remaining 400k is financed through debt (80%). So now think of this as a company in an LBO transaction. You profit by taking a small equity portion and growing it by 1) Paying down the debt portion with the CF from the business 2) Appreciation through making aspects of the business better
Therefore, in the case of the mortgage, that 100k investment becomes a 500k equity portion after the debt is paid down, but can become 500k+ through the home appreciating overtime. Essentially you get "free" equity. With an equal split of debt/equity, the LBO process would not be as effective since a normal company's optimal cap structure is 40-60% debt whereas an LBO is more like 70-80% debt.
Hope it helps.
ya, this isn’t right
Financing has a lot of different factors. You can absolutely do all debt if you’re a $50B company buying a $10B and your debt/EBITDA is still in line post transaction. Ideally, asssuming you’re getting a sub 10% interest rate, which most credit worthy companies should get, then you’d want all debt because as long as the incremental net expense (increased interest expense, write up of assets, etc) is less than the targets NI then its accretive. But again, the mix has to take into account messaging to investors, making sure you don’t take a notch on your credit rating, etc so often times you do a combo of debt and equity because that satisfies the most parties while still being accretive.
OP, LBOs are an entirely different story, not relevant in an M&A transaction. But the point is to borrow enough so that you’re covering a significant amount of the buyout while still generating enough CF to pay the interest on the debt.
Also, an LBO is only a transfer of ownership to PE/an individual, M&A is two companies combining into one which means you need to integrate the two businesses, which is probably the most critical part of any transaction since a bad integration is value destructive while a well done integration typically generates significant synergies and creates a unified culture that attracts talent/retains existing talent. Sorry for the long run on sentence haha
Thanks Greg appreciate the response. Definitely what I was looking for! The acquirer has sub investment grade credit rating and is already pretty geared (have it at 3x ND/EBITDA) but strong CF and forecasted to lever down ND over a 5 year period. Given that, is it still wise to pursue a partial debt acquisition?
Bumping with an additional question. If the acquirer is trading at a 52 week low, would it still make sense to have a split of debt and equity to raise capital?
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