One of the most critical points of negotiation in many business mergers is the companies’ debts. Corporate debt can play an outsized role in a merger transaction, including determining company valuation and merger price, transaction terms, or even whether the merger happens. Understanding business debt in the context of a merger will help your company pursue a favorable outcome in negotiations. Working with an experienced mergers and acquisitions (M&A) attorney can also help your business avoid many of the pitfalls that debt can pose for a merger.
Types of Debt in Mergers
In a merger, companies must consider two main types of debt that can affect the transaction: preexisting and acquisition debt. Preexisting debt includes each company’s liabilities to the transaction, including outstanding loans, corporate bonds, tax debts, and recurring legal liabilities. Preexisting debt can complicate merger transactions since the surviving company will likely assume the debts of both entities. When both companies in a merger have substantial debt, the resulting entity may assume too much debt to be viable as a going concern. When one company brings significant debt to the merger, it may scare off the other company as its leaders may worry about jeopardizing their business’s financial health by taking on another company’s debt.
Acquisition debt refers to the debt businesses incur to finance the merger transaction. In many mergers, parties may buy out other investors or shareholders to consummate the transaction. However, companies with little cash may take out loans to fund the merger consideration.
How Debt Affects Business Valuation and Purchase Price
Corporate debt can affect a business’s value and the ultimate purchase price in a merger transaction. One of the most basic ways to value a business includes the book value method, which adds up a company’s assets and liabilities and subtracts the two totals. Companies with substantial debt may have a lower value because more of their assets and income go to servicing and paying down their debt. They may also appear less attractive to potential merger partners since debt may raise concerns about the company’s long-term financial health. Debt may also affect the purchase price or consideration in a merger transaction as companies must consider what assets they will need to manage the surviving entity’s debts post-merger.
Considerations for Structuring Debt
When structuring preexisting and acquisition debt in a merger, companies must consider multiple factors to ensure that post-closing debts do not adversely affect cash flow and future financial health. First, companies must consider the share of debt arising from secured and unsecured debt. Secured debts relate to specific assets companies may have to keep ownership of. Conversely, unsecured debts may have less favorable terms due to the lack of assets securing the debt. Companies should also consider the share of short- and long-term debt. Short-term debts have a more immediate impact on cash flow, whereas companies may have the flexibility to restructure long-term debts.
Negotiating Liabilities in a Merger
Negotiating the issue of debts and liabilities in a merger begins with due diligence so that each party understands the complete scope of the other company’s liabilities. Hidden or poorly understood debt can throw off a company’s analysis of the viability of a merger. Parties should also structure the transaction to accommodate the parties’ respective debt obligations without jeopardizing the viability of the surviving entity. Managing debt may sometimes involve transferring debt to subsidiaries or spinoffs. Experienced legal counsel can help companies structure a merger transaction to appropriately manage preexisting and acquisition debts.
Contact an M&A Attorney Today to Understand Debt in the Context of Your Merger Transaction
When negotiating a merger, an experienced M&A attorney can help you understand how corporate debt will affect the terms of the transaction. Contact Sul Lee Law Firm PLLC today to speak with an experienced lawyer about how to manage the issue of debt in your business merger.