It looks like the party’s over when it comes to the low interest rate environment that dealmakers have enjoyed for many years. That means they may need get a little more creative when structuring transactions in order to avoid excessive financing costs. This Foley blog says that one alternative has been there all along – deals using a combination of cash & stock. Here’s an excerpt:
We have enjoyed low interest rates for years, leading to an increase in all-cash acquisitions. As valuations soared in 2021, we saw private equity firms seeking to mitigate risk by requiring sellers to roll a higher percentage of equity than ever before, sometimes at 50% levels and above. Mixed cash and stock deals have remained a common deal method, particularly for larger transactions. With interest rates on the rise, we could see even more of these mixed offerings, with more stock offered as borrowing cash becomes more expensive.
Rather than bridging the valuation gap with just an earn-out, private equity firms can structure equity on a subordinated basis for sellers and management, sometimes imposing a senior PIK dividend on top of the junior equity. As with any deal method, offering a mix of cash and stock comes with a mix of risks and rewards for both the buyer and the seller, and mixed offerings must be carefully structured to protect both parties. There are legal, tax, and accounting implications that must be taken into consideration when structuring these deals.
The blog acknowledges that all-cash deals can be faster and usually present fewer challenges, it points out that mixed consideration deals may be a good alternative for cash-poor buyers or those who want to preserve cash to finance future growth. However, they gain those benefits at the cost of the loss of a portion of control over the acquired business. Sellers also enjoy the potential upside of an ongoing equity stake in the acquired business, but along with that comes the risk of a deterioration in the value of that stake post-closing.
– John Jenkins