What happens to debt when a company gets acquired?


If I remember correctly, the acquirer has to refinance the seller's debt (so repay current debt by issuing new debt or paying for it with cash). Is this correct?

What about if a company is only selling a division? Will the buyer not take on any of the seller's debt, will it take a proportional amount, or does it vary from case to case?

This came up in a BB workshop that I attended recently. We calculate the EV of the division (by using the debt ratio of the seller as a whole), but got kinda stuck when it came to handling the debt. I suggest we assume that the buyer takes on a proportional amount, I'm just curious whether this is correct.


Comments (12)

Oct 31,2010

i think it all can be done depending on the setup of how the deal is done --- some may spin the debt off some may not as long as we are talking about divisions but of course this all makes the deal structured in a different way. if they acquire the whole company they obviously assume the debt but i am not sure whether or not they are forced to refi- i dont think they are though

im a trader not a banker :> so i may just be rambling

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Oct 31,2010

you take on all of the target's debt

Oct 31,2010

Whether or not you have to refinance all depends on the change of control clauses within the respective credit agreements and indentures.

Sometimes an acquirer may be able to take a companies debt onto its balance sheet but most often, they pay it off in cash (which could be raised through their own financing).

When it comes to divisions it all depends on deal structure and legal structure. If you are buying an operating division that is a separate subsidiary more often than not you will be forced to take on or pay out any debt issued at the entity you are purchasing. If the division spans multiple subsidiaries and parts of subsidiaries, it will all depend on deal structuring. For instance, if the deal is an asset purchase no liabilities, including debt, will be acquired. Note companies most often issue debt at a corporate parent and more often than not the individual subsidiaries being sold off will not be encumbered. That being said, they will often be guarantors under credit agreements and indentures or there will be covenants in those documents with respect to sales so the selling company may have to deal with issues although it wouldn't affect the acquirer.

To sum it up, at the end of the day a purchaser of a division almost never takes on any debt unless the debt is issued at specific subsidiaries in that division (which is a minority of the time).

I have never heard of it being done of a proportional basis, especially considering the difficulty in even determining how you would decide what the divisions respective proportion is.

Oct 31,2010

^^ thanks for the great answer!

Oct 31,2010

Great post. Sometimes the debt terms are advantageous and the acquiring company will just let it ride if the COC provisions allow for it. Sometimes the debt holders just want to be paid off in a company sale. Depends on the lender and terms.

Oct 31,2010

Think of it like a house, if I buy a house with a $100,000 down payment and $400,000 mortgage loan then the Enterprise Value is my $100,000 Equity Value + my $400,000 Net Debt, which equals $500,000 EV

Oct 31,2010

EV is considered the true / total value of acquiring a business. As a buyer, you want to take into account all parties that have a "stake" in the firm. Debt holders are owed money, and when a firm is acquired those debt holders will be paid out just like the equity holders. The acquiring firm's cost is both debt + equity of the acquired firm.

The reason that a DCF leads to Enterprise Value is that in a DCF, FCF that a firm generates is cash used to pay off equity AND debt holders (debt holders take interest out of FCF, and equity holders effectively receive the earnings that remain after all expenses) - it is "attributable" to both. The assumption here is that FCF is unlevered. Levered FCF is a company's FCF after all debt obligations have been paid (which is cash flow to equity holders) - if you used levered FCF in a DCF, you would result in equity value instead of EV.

Differentiating to equity value is just taking your 'implied enterprise value' calculated in the DCF and turning it into Equity value. You just do this using the normal EV formula EV = Equity + Debt + Minority Interest - Cash. Solve for Equity using balance sheet numbers: EV - Debt - Minority Interest + Cash = Equity value. Divide by shares outstanding for implied share price based on your model.

Hope that is helpful

Oct 31,2010

My experience is in the private sector; however, I can try and shed some light.

In most transactions I have been involved in, enterprise value is different than the proceeds the owner will actually receive. For example, my firm pays off all debt in acquisitions and assumes that the owner will walk away with the cash on the balance sheet. It is important to figure out the enterprise value of the firm so you do not under value the firm you are acquiring.

So the actual check my firm will give the owner is typically: Check = Equity value - debt - cash.

The owner will actually receive: Owner's Proceeds = Check + Cash. This can obviously change if the acquisition is a stock or asset sale. It also depends on negotiations on how much cash will be left on the balance sheet or how much debt the acquiring firm will assume.

Oct 31,2010