Paying & Financing an Acquisition

BMME303

Accounting, Analysis and Governance in Complex Deals

“No one spends other people’s money as carefully as they spend their own.”

M. Friedman

Financing an Acquisition

Sources of Payment?

Cash
  • Cash on Hand & Redundant Assets
  • Use your own money
Equity
  • Stock: backed by the firm’s cash-generating capabilities


Debt
  • Financial Sponsor
  • Use Other People’s Money
Mix?
  • Seller Financing
  • […]

Cash

Financing an Acquisition

Use Your Own Money

  • Cash on Hand: cash in excess of normal operating requirements on the acquirer’s or target’s balance sheet

  • Redundant Assets: assets owned by the acquirer or target firm that are not considered germane to the acquirer’s business strategy

See DePamphilis (2025) (Chapter 13)

Debt

Financing an Acquisition

Use Other People’s Money

  • Financial markets have created an almost unlimited range of financing options

  • Think of secured/collateral, unsecured, mezzanine, (junk) bonds, […]

  • Combinations → Seller Financing

  • Common strategies? → e.g., Leveraged Buyout

  • Employed by? → e.g., Private Equity

Seller Financing

Financing an Acquisition

Definition

Seller defers a portion of the purchase price (i.e., accepts a promissory note from the buyer)

Advantages
Seller • Buyer may be willing to pay the seller’s asking price due to deferral
• Makes the sale possible when bank financing is not available (e.g., 2008-2009)
Buyer • Shifts operational risk to the seller if the buyer defaults on the loan
• Enables the buyer to put in less cash at closing

Leveraged Buyout

Selected Financing Strategy

Financial Buyers/Sponsors

LBO

“In a leveraged buyout all of the stock, or assets, of a public or private corporation are bought by a small group of investors (financial buyers aka financial sponsors), often including members of existing management and a sponsor.”

DePamphilis (2025)


→ how do financial buyers differ from strategic buyers?

→ how is a LBO implemented (and by whom)?

Financial Buyers/Sponsors

LBO

Notes DePamphilis (2025)

“While there are exceptions, LBOs most often are used to finance relatively small transactions and, contrary to conventional wisdom, apply more often to privately-held firms than to publicly traded firms. The term financial sponsors generally applies to those contributing the equity portion of the purchase price and often applies to private equity investors, increasingly hedge funds, LBO funds, and buyout firms.”

Financial Buyers/Sponsors

LBO

Notes DePamphilis (2025)

“Financial buyers are investors interested in holding their investment for a relatively short period before liquidating their position through an IPO, sale to a strategic buyer, or sale to another financial buyer. Financial buyers usually do not have an operating unit into which the acquired firm can be merged to realize synergy. Such buyers usually create value by improving operational performance of the acquired unit, building equity through debt reduction, and through eventual sale of the business. In contrast, strategic buyers usually have a longer investment time horizon and create value through synergy resulting from merging the acquiring firm with the target firm.”

LBO as Financing Strategy

LBO as Financing Strategy

LBO as Financing Strategy

Implementation

  • LBOs are a commonly used financing strategy employed by Private Equity firms (i.e., financial buyer/sponsor) to acquire targets using mostly debt to pay for the acquisition

  • The sponsor establishes a Special Purpose Vehicle (SPV) with minimal equity and substantial debt for the acquisition of the target

  • Target firm assets are used as collateral for loans; post-acquisition downstream merger, so-called debt pushdown

  • Post-LBO, the debt-to-equity ratio is substantially higher than the pre-LBO ratio due to the debt incurred to buy shares from pre-buyout shareholders

Advantages and Disadvantages

LBO

Advantages

  • Tax savings (e.g., interest expense)

  • More efficient decision-making under private ownership & reduction in agency conflicts (in MBOs)

  • A potential improvement in operating performance

  • May serve as a takeover defense by eliminating public investors

Disadvantages

  • High fixed costs of debt raise the firm’s break-even point

  • Vulnerability to business cycle fluctuations and competitor actions

  • Not appropriate for firms with high growth prospects or high business risk

  • Potential difficulties in raising capital

MBO?

Private Equity

Private Equity Structure

Financing an Acquisition

PE Structure
PE Funds
  • PE firm as General Partner (GP): earns fees and carry: “2-20”
  • Limited Partners (LPs) provide capital: commitment to fund
  • Locked: no withdrawals & distributions at the GP’s discretion
  • Blind: LPs have no influence over investment decisions

E.g., see Ivashina (2023) on the 2-20 fee structure: 2% annual management fee on committed capital and 20% of profits over a certain hurdle.

LP Capital Commitment

Example

“If any Limited Partners (other than an Excused Partner with respect to a Portfolio Investment) fails to make, in a timely manner, all or any portion of any Capital Contribution, Direct Payment or any other payment required to be made by such Limited Partner hereunder, and such failure continues for five Business Days […] then such Limited Partner may be designated by the General Partner as in default under this Agreement (a Defaulting Partner) […] The General Partner may take any or all of the following actions with respect to a Defaulting Partner (i) reduce amounts otherwise distributable to such Defaulting Partner by 50% as of the date of such Default and withhold the remaining 50% of any future distributions that otherwise would be payable to such Defaulting Partner pursuant to Article VI until the dissolution of the Fund, (ii) cease to allocate any income and gain to such Defaulting Partner with respect to its remaining interest in the Fund, but continue to allocate its pro rata share of losses and deductions, (iii) require such Defaulting Partner to remain fully liable for payment of up to its pro rata share of Organizational Expenses and Fund Expenses as if the Default had not occurred.”

Ivashina (2023)

Private Equity Strategy

Financing an Acquisition

  1. Raise funds/equity from Limited Partners
  2. Acquire operating firms/targets using equity and multiple debt instruments
  3. Adjust operations/governance: incentivize management to maximize shareholder wealth, put General Partners on board of directors, optimize cash flow generation
  4. Resell the target within three to five years

Thank You!

Appendix

Management Buyout

LBO

Management Buyout (MBO) is a specific type of leveraged buyout where:

  • The existing management team of a firm purchases a controlling stake in the business they manage
  • Managers typically partner with financial sponsors (e.g., PE firms) to secure the necessary financing
  • Unlike traditional LBOs, MBOs may benefit from reduced information asymmetry since managers become (partial) owners of the firm


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References

DePamphilis, Donald M. 2025. Mergers, Acquisitions, and Other Restructuring Activities. Academic Press.
Ivashina, Victoria. 2023. “Chapter 4 - Private Equity Financing.” In Private Equity and Entrepreneurial Finance, edited by B. Espen Eckbo, Gordon M. Phillips, and Morten Sorensen, 1:139–60. Handbook of the Economics of Corporate Finance 1. North-Holland.