Chapter 7 - Financing Structures and Strategies

Abstract

This chapter focuses on reasons financing structures matter, the various alternatives for financing transactions, the complex capital structures of highly leveraged transactions, and ways of selecting the appropriate capital structure. A firm pursues a financing strategy that will result in a financing structure to maximize the value of the firm. The financial structure or capital structure is the dollar amount of debt compared to equity a firm uses to finance its growth in assets. The strategy for getting there is very important. A poorly designed financing strategy can have disastrous effects for buyers, sellers, and lenders. A properly structured financing strategy should be sufficiently flexible to allow for the kind of unforeseen event—the collapse of the credit markets—that had such an impact on the Home Depot deal. Flexibility includes not borrowing so much up front that it is impossible to borrow more in an emergency, and not borrowing at terms that become unrealistic if market conditions change unexpectedly—which they often do. Merger and acquisition (M&A) financing strategies or plans should be developed before negotiations are completed, and should include developing a balance sheet and income and cash flow statements for the combined firms. The financing plan also provides insights into the appropriate composition of the purchase price by projecting the potential for earnings per share dilution if the acquirer issues a substantial number of new shares. By simulating alternative financial structures, the acquirer can gain insights into what might constitute the least costly way of financing the transaction. The financing plan thus serves as a reality check for the buyer.