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How to fund an acquisition

A key consideration for a company acquiring another company is how to finance the acquisition. Most companies do not have the necessary cash reserves to complete an acquisition and therefore require additional funding to complete the purchase. There are two main sources of funds a company may use: debt finance or equity finance.

Debt finance involves borrowing money in order to finance the acquisition while equity finance involves issuing new shares.

Key methods of debt finance

The key methods of debt acquisition finance are:

  • Loans
  • Debt securities

Loans are the simplest form of debt and involve a company borrowing money, normally from a bank, to fund the acquisition. The loan may be secured on the assets of the buying company or the target company, provided they do not breach the rules on financial assistance in the Companies Act 2006.

If the target company is a publicly listed company, then the buying company (the bidder) will need to ensure that they are in a position to complete the offer, once it is accepted by shareholders. This requirement includes that the bidder has sufficient funds to complete the purchase. A bidder will, therefore, need to ensure they have a signed loan agreement in place and are unconditionally entitled to draw down funds on completion before making a public takeover offer. 

To finance an acquisition through debt securities, a company will issue notes or bonds to investors in return for money. Debt securities are financial instruments representing a debt from an issuer to an investor. They contain a promise for the issuer (the company) to repay a defined amount to an investor (the holder of the debt security). The obligation is usually to pay on or by a specified date.

Most debt securities are transferable, meaning that they can be bought or sold by an investor on a debt capital market.

For more information, read our guide to raising debt finance.

Key methods of equity finance

The key methods of equity acquisition finance are:

  • Rights issues
  • Placings
  • Cash box placings
  • Open offers
  • Vendor placings

What is a rights issue?

A rights issue is an offer of new shares to existing shareholders that is proportional to their existing shareholdings. Shares are paid for in cash and are nearly always issued at a discount to the current market share price. A key element of a rights issue is that the right to subscribe for shares has value in itself and a shareholder can sell this right without buying the shares. This is known as selling the rights ‘nil paid’.

Even if a shareholder does nothing, the shareholder has the right to receive any value over and above the subscription price if the shares are sold at a premium to the subscription price plus costs. Brokers are normally employed by the issuing company to sell any unwanted shares (known as ‘the rump’).

What is a placing?

A placing is an offer of shares for cash to selected investors. The offer is not proportional to existing shareholdings and may include new investors. In a placing, the recipients of the shares are usually institutional shareholders, who are likely to hold the shares as a long-term investment. Unlike a rights issue, placing shares are not offered to all shareholders but only to a sub-section of investors.

Under the Companies Act 2006, a company offering new shares must first offer them to existing shareholders before offering them to external shareholders. Listed companies will typically obtain a waiver from shareholder pre-emption rights to make a placing at their annual general meeting.  It is common for listing companies to obtain waivers to make cash placings of up to:

  • 5% existing issued ordinary share capital in a year
  • An additional 5% of existing ordinary share capital for an acquisition or capital investment
  • 7.5% of existing ordinary share capital on a cumulative basis in any three years

What is a bought deal?

A ‘bought deal’ is a type of placing where one investor takes a block of shares with a view to selling those shares on for a profit. Bought deals are normally conducted by large securities houses that take a number of shares with the intention of trading those shares for a profit.  

What is a cash box placing?

A cash box placing is a special kind of placing where the deal is structured as a share-for-share exchange, so as to avoid statutory pre-emption rights. Cash box placings tend to involve Jersey incorporated companies with multiple types of share capital.

The sole asset of the cash box company is cash, normally provided on a subscription of shares by an investment bank. The issuer will agree to issue new ordinary shares in exchange for taking ownership of the cash box company (and its money).  

What is an open offer?

An open offer is an offer of new shares to existing shareholders also on a pro rata basis. However, open rights do not use provisional allotment letters and can’t be sold by a shareholder nil paid. Further, under an open offer no arrangements are made for the sale of any shares not taken up by shareholders. 

What is a vendor place?

A vendor placing involves a buyer allotting shares to a seller in exchange for shares in a target company. The seller then agrees with an investment bank to place its shares in the market for a cash sum.

Debt financing vs equity financing: a comparison

The fundamental difference between debt and equity financing is one of ownership. In equity financing, the owners of a business give up part or all of their ownership in a company. By contrast, in debt financing the owners of a business do not change but the company becomes indebted to investors.

Despite the difference between equity finance and debt finance, both may involve securities. In equity finance, securities normally take the form of shares whereas bonds and notes are common forms of securities in debt finance.

Investors who acquire shares in a company will be entitled to the rights of a shareholder. These rights can include the right to receive a dividend and the right to vote in shareholder meetings. By contrast, debt investors are not entitled to vote in shareholder meetings nor are they entitled to share in a company’s dividends. Debt securities are commonly time limited and only entitle investors to receive payments for a limited period of time. Shareholders on the other hand remain entitled to vote and dividends for as long as they hold shares in a company.

Factors influencing fundraising structure

A company choosing between funding an acquisition via debt or equity will first and foremost wish to consider the cost of the finance. For example, a company will wish to weigh the costs of debt (fees, interest etc) against the cost of diluting its share capital.

Issuing new shares means diluting existing shareholdings and increasing the number of investors entitled to dividends and share buybacks. Depending on the type of equity issued, a company may also incur additional costs in preparing a prospectus and marketing new shares to investors.

A company will also wish to consider its existing capital structure. For example, companies with already high levels of borrowing may only be able to finance an acquisition through the issue of new shares. A company may also be restricted by existing loan agreements as to how much more they can borrow without their lender’s consent.

Finally, a company should consider the tax implications from their choice. For example, a company is allowed to deduct all expenses incurred for the purposes of its loan relationships. However, there is no tax relief available on dividend payments. More often than not this means that debt finance is more tax efficient than equity funding.


What next?

For more answers to commonly asked questions and advice on funding an acquisition, consult our corporate solicitors. Get in touch on 0800 689 1700, email us at enquiries@hjsolicitors.co.uk, or fill out the short form below with your enquiry.

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