Question

Continuing in your role as the Chief Financial Officer (CFO) of Anycorp Inc., you are interested in looking at the various financing options for the acquisition of Anycorp's defeated rival, Initech LLC. While your last inspection of financing options centered around debt financing, you're now interested in examining acquisition financing using equity (read: stock) financing. As in the prior case analysis and based on your readings from Chapter 7, prepare an Executive Summary discussing the various pros, cons, and tradeoffs of equity financing and whether an equity issuance would be appropriate for Anycorp's acquisitive needs. You should pay particular attention to issues of control, risk (financial, operational, mission, etc.), and sustainability. This should be done from the perspective of (primarily) Anycorp itself but, also, from the perspective of the investors in Anycorp's financing issue. Finally, and if you have space for it, please discuss the various tradeoffs between debt and equity financing that might crop up in an acquisition funding situation.

Answer 1

Equity financing;

Equity financing is the method of raising capital by selling company stock to investors. In return for the investment, the shareholders receive ownership interests in the company.

Advantage;

Ownership - The equity acquisition will result in ownership of the company where the buyer will be taking part in all the key decisions and management in substantial part. This makes them to put in the management skills and ideas to gain synergy benefit out of the acquisition.

Synergy is the concept that allows two or more companies to combine together and either generate more profits or reduce costs together.

No loan repayment - With equity financing, there is no loan to repay. The business doesn’t have to make a monthly loan payment which can be particularly important if the business doesn’t initially generate a profit.

Use of technical skills - With equity financing, you might form informal partnerships with more knowledgeable or experienced individuals.

Disadvantage:

Potential conflict - Sharing ownership and having to work with others could lead to some tension and even conflict if there are differences in vision, management style and ways of running the business.

Over valuation of acquisition company - The mechanism for takeover has lot of procedures and calculation. In target company, we need to normally compensate the equity shareholders with premiums in shares as they might be reluctant to get it acquired.

To arrive at consensus - The agreement for takeover involves consent of shareholders and board of directors of target company, and approval from stakeholders and board of acquirer company. (In this case, stakeholders is required as in case of banks, if there is any default in repayment of loan, the takeover might affect their interest)

Tradeoff:

The initial cost of obtaining equity finance might be high. But we will be able to enjoy the full benefit of profits whereas in debt financing, we will be able to only receive the net fixed interest from the debt provided and there will be no sharing of profits and technicals.

Equity finance will also reduce the management under one head and results in easy administration and saving cost of double works

From the perspective of The Anycorp Inc.,

Equity finance leads to full control of the business. In this case, there are two types of acquisition, via the company directly purchasing the shares of target or the shareholders acquiring the target, the difference lies only with cash flows and accounting. But the control remains the same considering the proportion of acquisition between all shareholders.

Risk in equity finance is higher. The financial risk involves inadequate cash flow on utilising major portion for acquitision. Or additional liability of repayment of loan which is obtained for the acquisition.

Sustainability is more in equity fiance as it is the direct ownership which is one of the major advantages of equity finance.

From the perspective of investors.,

Equity finance add value to the shares, thereby taking major control. Share capital will be increased in both case where shareholders acquire or the company directly acquires.

Risk is high. The company has much higher risk. As in case of shareholders, the risk gets diluted as there are many shareholders and it will not affect them directly. In either case, they have backup of existing company profits to withhold loss of target company, if any.

Sustainable measure is to acquire through equity finance as it involves major collaboration.

The joint venture form of equity can also be used for this case where technical contribution is more and results in effective profit maximisation.