Acquisition Debt Details

When companies purchase other companies, they often do so through a leveraged buyout (LBO). This is an approach mostly funded by acquisition debt. The wisdom in obtaining acquisition debt lies in purchasing the target company through a loan secured against that target entity’s assets. In more aggressive buyouts, the acquirer uses the acquired entity’s own assets as collateral.

In any case, the acquirer should see to it that the other company’s assets are sufficient for the said purpose before taking on debt. They should also analyze the potential merger’s financial forecasts to make sure they can pay off the loan on time.

As soon as the acquirer establishes the financial feasibility of the planned acquisition, it begins to scout for a funding source. This can be a bank or banks, or bonds issued by that company in the open market. Generally, acquirers are more interested in pursuing acquisition debt when interest rates are low or when company values are on a downtrend due to the underperformance of certain industries or the overall economy.

Acquisition Debt Real World Example

In 2016, imaging and semiconductor company Tessera Technologies, Inc. acquired audio solutions innovator DTS, Inc., for $42.50 per share. This was 28% on top of the acquired company’s volume-weighted average price over 30 days up to September of the same year. Tessera funded the buyout with some cash on hand. But it mostly funded it with $600 million in acquisition debt the company secured from global investment bank RBC Capital Markets.

Different companies can have different reasons for pursuing acquisitions. These can include portfolio diversification, asset increase, improved tax efficiency, and more, or any combination thereof. In the case of Tessera, the goal was to expand its product line and market reach, specifically through the introduction of a new breed of cutting-edge audio solutions.

Significance of an Acquisition Debt

As mentioned, acquisition debts can be used for different reasons, but the bottom line is to make a large acquisition with as little capital as possible. Ultimately, this is expected to maximize shareholder value. The more the debt increases profit efficiency, the more shareholders will want it. If the potential rewards are not proportional to the cost of the debt, the company is better off foregoing it to avoid bankruptcy.

In most cases, companies trim down their debt through a term out, or by substituting it with longer-term loans and bonds and relying on cash flow. The idea is to lock in the interest rates instead of avoiding floating interest rates. By drawing out their payment terms, companies also get much-needed financial leeway.

Businesses are known to take on acquisition debt, so they don’t have to issue new shares. Issuing new shares reduces shareholder gains and harms their stock price. Another reason is to take advantage of positive tax treatment for debt. For example, since debt payments are considered business expenses, they are tax-deductible.