Thursday, June 25, 2015

A Quick Overview of Acquisition Finance

 As readers of our blog know, Joe and I teach an Acquisition Finance Course in Amsterdam every year.  The current offering is scheduled for December 9-11, 2015.  Information can be obtained here.

Acquisition finance involves structuring a deal to best obtain the objectives of the various parties involved.  There are numerous considerations in this process and we spend quite a bit of time in the course analyzing and illustrating best practices.  In today’s post, I’ll just outline a few of the basics.

Finding the optimal financial structure for a deal leads one inevitably to the topic of capital structure – the best mix of debt, equity and hybrid securities for a particular situation.  At the heart of this is the desire to minimize the cost of capital, while also being cognizant of risk, flexibility and requirements (and personal desires) of buyers, sellers, regulators and suppliers of funds.

Two major techniques for finding the best financing solution for a deal are the cash flow and asset based approaches.  Let’s take the latter first.  When we complete a deal, it is the assets that we are financing.  As we all know, Assets must equal Liabilities plus Equity.  Thus, the left hand side of the balance sheet (assets) must equal the right hand side (Liabilities plus Equity).  A given set of assets suggests particular opportunities with regard to risk, liquidity and the use of collateral. 

It is important to note that when we structure a deal, the securities we use (debt, equity and hybrids) are merely claims against the assets and against the cash flows generated by those assets.  That is, the securities are merely contracts promising particular provisions for the future.  And – while there are standard contracts for debt and equity, a contract is merely an agreement – it can be crafted, altered and structured in any way the parties can agree upon.  Thus, ultimately some deals are completed with more creative (non-standard) structures such as earn outs and other contingent payments.

The cash flow approach to acquisition finance is easy to understand.  Returns to the suppliers of capital will ultimately be generated from the cash flows of the business.  These include ordinary cash flows from running the business as well as one-time cash flows from spinoffs and asset sales.  A given cash flow projection suggests the level of risk inherent in the deal.  Generally, the returns (payments) promised will be compared with the funds projected to cover these payments.  Ratios like Times Interest Earned and Fixed Charges Coverage and tools like simulations are used to help assess deal risk. 

The paragraphs above provide just a sketch of the myriad considerations in structuring a deal.   One thing that is missing – and that we always emphasize in our class - is the analysis of markets.  That is, the paragraphs above outline some of the important items related to the parties involved and the deal itself.  But capital is raised in dynamic capital markets and different markets suggest different opportunities.  We’ll continue with an elaboration of these and other factors in subsequent posts.

All the best,


No comments:

Post a Comment