Types of Debt Used in M&A Deals
Debt can help Buyer make an acquisition by leveraging Buyer’s existing capital. The following covers the different types of debt common in M&A, so dig in!
M&A senior lenders
A senior lender is usually a bank that lends a company money, often for the express purpose of financing an acquisition. As the name implies, this lender is senior to all other lenders, which means that the senior lender gets paid before the other lenders in the event the borrower goes bankrupt. A loan from a senior lender is called a senior loan.
Subordinated debt in M&A deals
Subordinated debt, often called sub debt, is a strip of capital similar to senior debt; however, the lender purposefully agrees to take a back seat to the senior lender. A lender willing to subordinate itself to the senior lender does so in exchange for a higher rate of return.
Mezzanine debt (or simply mezz) is a form of sub debt that usually has some sort of equity component (usually in the form of a warrant, which is the right to buy stock in the future at a low price).
Lines of credit
A line of credit (LOC) is simply a loan from a bank, often used to help finance acquisitions. Unlike a senior loan, the borrower pays interest on the amount it has used. A company may have a $5 million LOC, but if it has only tapped $2 million to help pay for an acquisition, the company only pays interest on the $2 million, not the full $5 million available.
A revolver is a type of LOC designed to help with the short-term cash flow needs of a business. A revolver is helpful to a company whose cash reserves are low (perhaps because it just spent some money making an acquisition) and that needs to pay bills even though its clients are a wee bit slow in paying. Making payroll is usually the main reason for establishing a revolver.
To help during a cash crunch, a company may establish a revolver with a bank. If the company needs cash, it utilizes the cash on its revolver and then repays the revolver as clients remit payment to the company.