Previously, we noted that it is important to work with experienced legal counsel to properly prepare for and navigate merger and acquisition transactions. These transactions affect acquiring companies and target companies differently. For acquiring companies, it important to consider how a proposed transaction would affect its capital structure.
Capital structure refers to the composition of a company’s permanent, long-term capital. In other words, it is a company’s debt to equity combination. For any company making use of debt, there should be a healthy proportion of equity capital to debt capital. For companies contemplating a merger or acquisition, the transaction price, the way companies choose to finance the deal, and the prospects for future growth and profitability can affect not only capital structure, but also the way the market responds to the transaction, and its long-term success.
In terms of financing, some mergers and acquisitions are financed solely by cash, which allows the acquiring company to avoid taking on additional debt, but it also decreases the acquiring company’s cash holdings. Mergers and acquisitions can also be financed through debt, which can be offset by the additional cash flow. Mergers and acquisitions may also be financed by the acquiring company’s stock, particularly when share prices are high and the company is well-known, successful and respected.
However a merger or acquisition transaction is financed, the price has to be reflective of the value the acquisition will bring to the acquiring company, otherwise investors could perceive the transaction negatively and there is a larger risk of failure. Mergers and acquisitions which don’t make strategic sense for the acquiring company are more likely to have a negative outcome.
In any merger or acquisition, it is important to work with an experienced attorney to come up with an effective strategy and to address any risks presented by the transaction. The larger the target company, the greater the risk for the acquiring company and the more need there is for sound legal advice and advocacy.
Investopedia.com, “How Mergers and Acquisitions Can Affect A Company,” Elvis Picardo, Oct. 29, 2014
Investopedia.com, “Evaluating a Company’s Capital Structure,” Richard Loth, Jan. 27, 2017.