Principal Attorney
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. Proper due diligence and careful transaction planning can help businesses identify potential liabilities before closing and reduce the risk of costly surprises after the merger is complete.
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
Preexisting debt includes each company’s liabilities before the transaction, including outstanding loans, corporate bonds, tax debts, lease obligations, 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 remain financially viable.
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. Not all liabilities are immediately obvious during negotiations. Businesses should also evaluate contingent liabilities, pending litigation, contractual obligations, and potential regulatory issues that could affect the value of the transaction after closing.
Acquisition 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.
While acquisition financing can make a transaction possible, businesses should carefully evaluate how new debt will affect cash flow, future growth, and the combined company’s ability to meet its financial obligations after the merger closes.
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.
Depending on the circumstances, debt may also influence other aspects of the transaction, such as indemnification provisions, escrow arrangements, purchase price adjustments, or financing contingencies designed to allocate risk between the parties.
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.
Businesses should also review existing loan agreements for change-of-control provisions or lender consent requirements that may be triggered by the merger. Identifying these requirements early can help avoid delays or unexpected complications during the transaction.
Negotiating Liabilities in a Merger
Negotiating the issue of debts and liabilities in a merger begins with thorough due diligence so that each party understands the complete scope of the other company’s financial obligations. Hidden or poorly understood debt can significantly affect a company’s analysis of the transaction and the viability of the merger.
A comprehensive due diligence review should evaluate:
- Financial statements and outstanding loan agreements
- Tax records and potential tax liabilities
- Pending litigation and other legal obligations
- Major contracts that may contain debt-related or change-of-control provisions
- Contingent liabilities and other obligations that could affect the combined business after closing
Once both parties understand the company’s liabilities, they can negotiate how those obligations will be handled. Depending on the transaction, this may include:
- Paying off certain debts before closing
- Refinancing existing loans
- Allocating specific liabilities between the buyer and seller
- Transferring debt to subsidiaries or spin-offs when appropriate
Experienced legal counsel can help structure the transaction to appropriately manage both preexisting and acquisition debt while protecting the long-term financial health of the surviving business.
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. From conducting due diligence to negotiating liability allocation and drafting transaction documents, experienced legal counsel can help businesses navigate complex mergers while protecting their long-term interests.
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.