What Does Acquisition Financing Mean?
Acquisition financing is the funding that an acquirer obtains to finance the purchase of a target company. This financing can take a number of different forms including debt, equity or some form of hybrid instrument.
The range of alternatives available to an acquirer will typically be situation-specific and will depend on, among other things, the acquirer’s current balance sheet, the amount of financing required, the nature of the business being acquired and whether the acquirer is willing to give up an ownership stake.
Divestopedia Explains Acquisition Financing
Debt, whether from a bank or non-bank lender, will typically be the lowest cost financing alternative, but will be dependent on the acquirer (or the target company) having assets that can be used as collateral as well as the acquirer’s ability to demonstrate that it will have sufficient cash flows to service the loan.
In some circumstances, mezzanine debt may also be available to an acquirer. Mezzanine lenders are typically less reliant on the acquirer providing collateral and will place a greater focus on the acquirer’s ability to service the debt based on future cash flows. Given the higher risk associated with mezzanine debt, lenders will typically demand a higher rate of return (i.e., interest rate) making this alternative a higher cost form of financing than a traditional bank loan.
Equity financing involves a sale of an ownership interest in the acquirer to a third-party investor, and typically takes the form of a purchase of shares. Although there is generally no immediate cost to issuing equity, it is generally the most expensive financing alternative as the acquirer is effectively giving up a share of all the future value created by the company.
Finally, there are a variety of hybrid financing vehicles that incorporate certain features of both debt and equity. Typical features include liquidity preference (i.e., they rank above equity but behind debt in terms of receiving a return), convertibility into common equity and warrants giving the investor the right to acquire an additional equity interest in the acquirer, among others. The financing cost of this type of financing varies greatly, but will generally be somewhere between the cost of debt and equity,