California Mergers and Acquisitions: Reasons to Assume the Target’s Debt
In the news recently is the announcement by fast-food chain Arby’s Restaurant Group that it will acquire Buffalo Wild Wings for $2.4 billion in cash. The deal calls for Arby’s to pay $157 per share in Buffalo Wild Wings stock. Interestingly enough, Arby’s will also assume the debt of Buffalo Wild Wings. Details are not publicly known — particularly details with regard to the debt — but, with the turning of the new year, the Arby’s/BWW deal gives us the opportunity to discuss a couple of reasons why a company acquiring another might want to assume the target’s debt obligations.
California Mergers and Acquisitions: General Principles
There are a multitude of ways to structure a merger and/or an acquisition. In practice, it depends entirely on the desires of the parties, what purposes are being sought and accomplished, what price is being asked, what consideration can be paid, etc. That being said, at the most general level, mergers and acquisitions can be accomplished in three ways:
- Acquiring business buys the target entity: For example, a stock purchase like Arby’s is proposing for BWW; this can be without assuming debt and liabilities of the target or the opposite or some combination thereof.
- Asset purchase: The target entity generally ceases to exist (at least within the market or area); often the mechanism used to avoid assuming any of the target’s liabilities or if regulatory hurdles are raised.
- Complete merger: Both acquiring entity and the target are merged into a new business entity/structure — generally a liability-assuming type of merger.
California Mergers and Acquisitions: Some Reasons for Assuming the Target’s Debts
In general, there are two reasons an acquiring entity might want to accept the debt of the target. Accepting the target’s debt is the only way to accomplish the deal, and the target has “good debt,” that is, a favorable capital/debt structure.
Take this simple example: You own a pretzel cart business. You want to expand your market share and, as luck would have it, your neighbor owns a pretzel cart business, too. You ask to buy it. (For this example, we will ignore the vast oversimplifications, need for lender consents, etc.)
In general, the price you pay for a going business is either its enterprise value — value including the debt — or its equity value — the value without debt. Let’s assume you have $10,000 and only $10,000 to buy your neighbor’s business. After doing your due diligence, it turns out that equity value is $20,000, but the enterprise value is $10,000. The only way the deal gets done is if you buy the business and assume its debt.
Now let’s assume you have $20,000 in cash. In this version of the hypothetical, you could ask your neighbor to pay off all the debts — or, more realistically, pay the debt off at the closing — and pay the equity value of $20,000. However, you and your trusted and talented business lawyer have done your due diligence and have discovered that the target’s debt structure is favorable. Let’s say, somehow, all of his loans have a 1% interest rate. Under those circumstances, it makes better economic sense to pay $10,000 and assuming the target’s debt. A real-world example might be where the target has an industrial development bond from the local government with a low interest rate or other favorable terms.
California Mergers and Acquisitions: Beyond “Debts,” Many Other Types of Liabilities
It must be remembered that there are other types of liabilities beyond simple debts like bank financing and investment loans. Other liabilities might include contractual obligations under leases and other business contracts as well as threatened litigation liabilities for torts or other negligence. Acquiring a target through a stock purchase generally means the acquiring entity is assuming all liabilities, not just financial debt. All mergers and acquisitions are complex, must be carefully evaluated, and should be structured so that all the parties are obtaining the desired results.
Contact San Diego Corporate Law
If your company is planning a merger or planning to acquire a competitor, you need an experienced M&A attorney like Michael Leonard, Esq. of San Diego Corporate Law. Contact San Diego Corporate Law and get the skilled guidance that you need. Contact Mr. Leonard by email or by calling (858) 483-9200. We look forward to helping you expand your business and seize marketshare.