Question

Are there any advantages or disadvantages for a heavily indebted company that accumulated that debt following a leveraged buyout during a workout process, i.e., a company in financial distress, compared with a publicly-traded company with significantly greater value of equity than debt? Answer as completely as possible.

Answer 1

There are significant disadvantage if you are buying a heavily indebted business. However, if your business has the ability to turn around the target company, then these disadvantages can become your advantages.

a. Taking on an indebted company means, the debt on the balance sheet of the target company will come on to the balance sheet of the acquirer. If the acquirer is a publicly traded company, the shareholders of the acquirer will not be happy as they have to on additionally debt.

b. The increased debt will increase the cost of capital or WACC for the business as a whole since increased debt increases cost of debt and cost of equity.

c. The employees of the target company may have to be laid off due to different styles of functioning and hence the top management of the acquiring business may have added difficulty in turning around the indebted business

d. The acquiring business may have to pledge some of the shares of its own company to the borrowers until the acquirer gets enough time to turn around the ailing business of the target.

e. However, if the acquiring business has the ability to turnaround the indebted business through the ability of its top management and also its processes, these can be added advantages to the business of the acquirer on the long run.