What is Fundraising?
Fundraising is the act of raising capital from investors by selling securities in a company, typically shares or bonds. It’s the opposite of going public and selling to the general public through an Initial Public Offering (IPO). According to Fintalent’s fundraising consultants, once you go public you have shareholders and regular reporting requirements.
If a company that is looking to undertake a merger or acquisition needs to raise funds for the transaction, it will likely borrow money using both secured and unsecured debt instruments, issue more securities such as more preferred stock (instead of just selling more common stock), issue convertible preferred stock and/or assets that include private holdings such as real estate, royalties or intellectual property.
In some countries such as the United Kingdom, companies do not need to raise funds for an acquisition other than a relatively small amount through their bank. In the United States, companies usually need to raise capital in the form of debt or equity (through a private placement) in order to acquire another company. At least one share of stock or security must be sold to fund an acquisition (the same amount of shares being acquired in a merger) and then those securities are traded on an exchange.
When do they do it?
Generally speaking, companies that have existing shareholders are more likely to engage with syndicate banks (banks that specialize in syndicated loans) than the public markets for funding. After all, if a company is looking to buy another company or part of another company that doesn’t have any shareholders, it might not need to issue securities to acquire the target company.
The decision to use debt and/or equity to fund a merger or acquisition depends on the situation. The target company may have existing shareholders while the acquiring company may not. In this case, equity would be used first and only if there were no other options would more debt be issued.
Debt instruments are usually more expensive than equity because lenders take higher risks than shareholders who stand behind the actual assets of a business. Of course, those risks mean that there is a greater upside for both the lender and the borrower, but there’s also a higher likelihood of losing money.
Secured or Unsecured Debt Instruments?
Debt instruments can include secured debt or unsecured debt. Secured debt is secured with collateral such as assets. The assets are pledged and loaned to the lenders while the lender is required to repay the asset with interest (like an IOU). Depending on the type of security that’s used, these can be collateralized by cash (certificates of deposit), accounts receivable and inventory (secured by an IOU), real estate, leasehold interests, etc.
Ordinary unsecured debt includes promissory notes, bonds and other unsecured debt instruments. These are loans that don’t require collateral or the pledge of assets. With these debt instruments, lenders rarely demand collateral on the loan while they typically want interest payments or even full repayment at some point in the future.
Why do they issue debt instruments?
Companies use debt and/or equity as a tool to finance acquisitions because it allows them to raise funds from regular investors and makes profitable companies eager to sell their company. Because of this, companies have less pressure to turn a profit, sit on cash waiting for a better time and are more willing to take more risks when financing an acquisition.
Debt is cheaper than stock, but it also comes with more conditions. Since lenders don’t have a voice in how the company is run, they can’t vote on corporate governance matters and their main concern is getting their money back. Another reason a company might issue debt securities instead of common stock is that it doesn’t want to issue shares that dilute the existing shareholders (such as in an acquisition where existing shareholders will get shares in the target company instead of cash).
For example, if Company A was looking to acquire Company B and keep its shareholders whole, it might use high-yield bonds (junk bonds) as part of its capital structure for the merger. These securities are the cheapest (lowest) form of debt, but they come with the highest interest rate and they must be paid back before the maturity date. Unsecured loans or unsecured debt securities are usually preferred to this type of debt instrument because they allow a company to extend the repayment period as long as possible by including other long-term assets in the collateralization.
As you can see, there are more reasons that a company will release debts rather than equity. The types of securities used will depend on a number of factors including how much risk is involved by using unsecured instruments, whether or not credit will be provided by any banks and if there’s still an appetite for purchasing additional shares from existing shareholders.
Of course, the size of the transaction will also play a role. For a small amount of financing (less than $10 million) without bank credit, then an unsecured loan might be the best option. For transactions that involve more money, then secured debt can be used such as bonds and even some combination of bank loans and bonds.
The Bottom Line
Companies issue debt and/or equity based on their needs. Some companies raise capital through securities such as bonds, while others use bank loans or other assets to make up for the difference in size between what they need to acquire another company and their existing cash reserves.
However, not all companies are looking to raise funds through debt. Some have the cash on hand that they need to purchase another business. For example, a company might want to buy another company with minimal cash reserves and no shareholders other than its founders in order to make it more cost effective. If this is the case, then the process is called an acquisition of or by a private company (private deal). Whether a public or private company is doing the financing for an acquisition, there are still some general rules that apply. The specifics will depend on who’s doing the financing for each merger or acquisition and what kind of debt/equity instrument is used as part of their financing structure.