Financing an m&a transaction introduction

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Equity financing
Consists of a company raising money by issuing additional ordinary or preferred shares to existing or new shareholders. The amount of equity financing will depend on the amount of funds that existing or new shareholders are willing to make available for proposed transaction. Hence, the amount of equity will depend on the investor’s perception of the value brought by the transaction to the business.
Debt financing is where a company borrows money. Debt raised can be either traded in the capital market or loaned directly by a bank or via syndication.
Debt financing is attractive because financing costs can be deductible from taxable income if properly structured. There is the possibility of decreasing financing costs by using assets as collateral. The amount of debt raised may, however, be limited; it will actually depend on the amount of cash flow available to service debt.
The Choice between debt and equity or a combination of the two will depend on many factors:

    • The macroeconomic situation

    • Financial considerations such as cash flow, leverage ratios, credit ratings, and tax

    • Management culture such as the inclination to keep flexibility in a business

    • Shareholder preferences, and

    • Whether the company is listed and publicly traded or privately held.

Internal versus external financing
The choice between internal financing within the group and external financing from third parties will generally be made on purely commercial terms, based on the overall cash resources of the multinational.
The decision to use external funding if borrowed directly by the local entity rather than by the foreign parent will ensure that thin capitalization rules have no application
For this reason, the tax regulations very often contain anti-avoidance provisions which do not allow back-to-back loan arrangements between the foreign parent and an “external lender”.
From a taxation perspective, the choice between internal and external financing and of borrowing entities will be governed by the rule that interest should be paid in the highest taxing jurisdiction, and received in the lowest. In the larger context of mergers and acquisitions, however, it will be important to ensure that the chosen borrowing entity has the capacity to absorb the interest deduction, or can transfer it to entities which do have such a capacity

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