What it is:
How it works/Example:
The basic idea behind acquisition loans is that the acquirer purchases the target with a collateralized by the target’s own assets. In hostile takeover situations, the use of the target’s assets to secure for the acquirer is one reason that the tactic has a predatory reputation.
To obtain an acquisition loan, the acquirer must therefore first make sure the target’s assets are adequate for the loan needed to purchase the target. The acquirer must also create and study financial forecasts of the combined entities to make sure they generate enough to make the and interest payments. In some cases, maintaining optimal could be a real challenge if the target’s management team leaves after the .
In some cases, an acquisition loan can come directly from one or more banks. (Sometimes in the .) Obtaining acquisition loans is often expensive and complicated, and when a particular deal is especially large, there is often more than one acquirer, which allows for sharing of the risks and expenses (and rewards). An investment bank, a law firm and third-party accountants are often necessary to correctly structure the loan and the transaction.
Why it matters:
The purpose an acquisition loan is to make a large acquisition creates a stronger, more efficient, more profitable entity, then most shareholders agree the is worth the trouble. But if debt levels are too large or the synergy just isn’t there, the company may not be able to service its debt and could go bankrupt.
This high level of risk is why share prices usually fall when a company announces news of an acquisition involving a of debt. This, however, can be a buying opportunity if investors think the company be able to pay down the debt, which increases the value of the .
The pursuit of acquisition loans usually increases when interest rates are low (this reduces the cost of borrowing and encourages investors to seek high-return opportunities) and/or when the or a particular industry is underperforming (and thus company values are falling). However, an increase could also signal more competition for deals, which tends to bid up the price for targets, further increasing the debt needed for acquisitions and increasing the chances a combined entity won’t be able to its debt obligations.