Financing an Acquisition

Agreeing on a price is only half of doing an acquisition; the acquirer also has to come up with the money. Four broad sources are available, usually in some combination: cash already on the balance sheet, newly raised debt, newly issued equity, or the target's own stock (in a stock-for-stock deal). Which mix is used shapes the acquirer's post-deal leverage, how much existing shareholders are diluted, and how much execution risk sits between signing and closing.

The main sources

Cash on hand is the simplest: no new securities are issued, no lender approval is needed, and the deal can close as fast as other conditions (like antitrust) allow. Its limit is obvious — most acquirers don't have enough idle cash to fund a large deal without also raising something else.

Debt financing — new bonds or bank loans raised specifically for the deal — lets the acquirer avoid diluting existing shareholders, and interest is tax-deductible, but it raises the combined company's leverage and interest burden, sometimes enough to threaten its credit rating. Debt-financed deals typically come with a financing condition or a committed financing letter from banks, since a large debt package this size can't usually be assembled overnight.

Equity financing — issuing new acquirer shares, either to the target's shareholders directly (a stock deal) or sold to the public/institutional investors to raise cash — avoids adding leverage, but dilutes existing shareholders' ownership and, if used as deal consideration, ties the target's payout to the acquirer's own stock price.

Worked example

An acquirer agrees to pay $2 billion for a target, funded with $500 million of cash on hand, $1 billion of new debt, and $500 million of newly issued acquirer shares.

1. Cash portion: $500 million comes straight off the acquirer's balance sheet — no new securities, immediate and certain.
2. Debt portion: $1 billion is raised through a new term loan, committed by banks at signing but not funded until closing — the acquirer's leverage rises by $1 billion the moment the deal closes, and its annual interest expense rises by whatever rate the debt carries, say 6%, or $60 million a year.
3. Equity portion: the acquirer issues $500 million of new shares at its current $100 price, or 5 million new shares — existing shareholders' ownership percentage shrinks accordingly, though the acquirer avoids adding that $500 million to its debt load.

What this means in practice

Financing conditions are one of the sharpest edges in deal risk: if a deal's financing is not fully committed at signing, or the debt markets deteriorate before closing, an acquirer can find itself unable to fund a deal it's contractually obligated to complete — which is exactly the scenario reverse termination fees exist to address, compensating the target if the acquirer's financing falls through.