Syllabus C. Acquisitions And Mergers C4. Financing acquisitions and mergers

C4ab. Methods of raising cash 2 / 5

Syllabus C4ab)

a) Compare the various sources of financing available for a proposed cash-based acquisition.

b) Evaluate the advantages and disadvantages of a financial offer for a given acquisition proposal using pure or mixed mode financing and recommend the most appropriate offer to be made.

The predator company can raise cash from many sources to finance the acquisition, some of the sources are:

Borrowing to obtain cash

The predator company may not have enough cash immediately available to finance the acquisition and may have to raise the necessary cash through bank loans and issuing of debt instruments.

Mezzanine finance

Mezzanine finance is a form of finance that combines features of both debt and equity.
It is usually used when the company has used all bank borrowing capacity and cannot also raise equity capital.

It is a form of borrowing which enables a company to move above what is considered as acceptable levels of gearing. 

It is therefore of higher risk than normal forms of borrowing.

Mezzanine finance is often unsecured.

It offers equity participation in the company either through warrants or share options.

If the venture being financed is successful the lender can obtain an equity stake in the company.

Retained earnings

This method is used when the predator company has accumulated profits over time and is appropriate when the acquisition involves a small company and the consideration is reasonably low. 

This method may be the cheapest option of finance.

Vendor placing

In a vendor placing the predator company issues its shares by placing the shares with institutional investors to raise the cash required to pay the target shareholders.

Leveraged buy-outs (LBO)

is a takeover of a company by an investor (often private equity) using significant debt. 

Typically the debt used to fund the takeover is secured on the assets of the target company. 

The cashflow generated by the target company is then used to service and repay the debt. 

The target company would normally need to have low existing debt, stable cashflows and good asset backing.

This approach allows a private equity investor to acquire a large company with minimal cash or risk, since they are borrowing against the acquired company's assets and earnings. 

A range of different debt is usually used and any short-term debt instruments may need re-financing soon after the deal. 

The overall aim is to improve the running of the target over a 3-5 year period, generate additional profits, repay the debt and sell the company for a profit.