INTM578090 - Thin capitalisation: debt ratios - debt repayment: Groups or companies in particular phases: major acquisition

As with businesses in expansion through organic growth - see INTM578070 - third-party lenders are often prepared to tolerate higher than normal debt:EBITDA or debt:equity ratios for a period of time following the acquisition of another business. This is dependent, however, on a number of factors:

• The borrowing business must be soundly financed and capable of servicing its debts. This may critically depend on the cost savings or synergies which are predicted to arise from the acquisition. In an arm’s length acquisition, these will have been analysed carefully by the acquiring group, and built into the costings of the deal. This is the due diligence process, through which the potential acquirer assesses the value of the target. This information may not be available where the acquisition has taken place at a global level e.g. where a US-owned worldwide group acquires another US-owned worldwide group, and the two enterprises are later merged at regional level with, say, the European subsidiaries of the acquired group being placed under the ownership of the acquirer’s European HQ company.
• The borrower should have a business plan that includes reasonable projections for profits over at least the life of the loan, and the underlying assumptions of the plan should be realistic and reasonable.
• It should be able to predict, with supporting evidence, how it will reduce the gearing ratio over a reasonable period of time. The time period may vary according to the size of the acquisition, but is normally unlikely to be much more than about three to five years. The reduction may either be by the repayment of some of the debt or the introduction of more equity, or a combination of both.