INTM579080 - Thin capitalisation: debt: equity ratio

Groups or companies in acquisition mode

As with businesses in expansion mode – see INTM579070 – third-party lenders are often prepared to tolerate increased 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 demonstrably capable of servicing its debts. This may critically depend upon the cost savings, or synergies, involved in the acquisition.
• It 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 reasonable.
• It should be able to predict, with supporting evidence, how it will reduce the debt:equity 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 introduction of more equity or by the retirement of some of the debt, or a combination of both.