Thin capitalisation: practical guidance: measuring debt: groups/companies in acquisition mode
As with businesses in expansion through organic growth - see INTM517070, third-party lenders are sometimes 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 their financial projections. This is part of the process of assessing the target’s value. This information may not be available where the acquisition has taken place at a global level, for example, 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.
These business plans should include reasonable projections for profits over at least the life of the loan, and the underlying assumptions of the plan should be realistic and reasonable.
- The borrower 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 and the level of reorganisation costs, redundancy costs, etc, incurred post-acquisition, but levels of debt often start to be reduced significantly within three to five years.