Chapter 13 - Financing the deal: private equity, hedge funds, and other sources of financing

Abstract

This chapter discusses common sources of mergers and acquisitions financing ranging from debt to equity to seller financing, the role of private and public financial markets in such financing, the impact of the US Tax Cuts and Jobs Act (TCJA) of 2017 on financing strategies, and how capital structure can affect abnormal financial acquirer returns. The chapter also includes a “short-hand” estimation of the portion of interest expense that will be tax deductible under the new tax law. The implications of the 2021 transition from London Interbank Offered Rate (LIBOR)–based loans to those based on the Secured Overnight Financing Rate (SOFR) rate are explored. How private equity and hedge funds serve as financial intermediaries and lenders of last resort for undercapitalized firms and financing highly leveraged transactions is addressed in detail. Highly leveraged transactions, typically referred to as leveraged buyouts (LBOs), are discussed in the context of a financing strategy in which leverage is used to magnify investor returns. This chapter also describes the changing nature of LBOs; how they create value; and their impact on innovation, firm performance, and employment, as well as factors contributing to their success, typical capital and deal structures, and the pitfalls of improperly structured LBOs.