CFA Level II ExamCorporate IssuersMedium
A company is evaluating a potential acquisition target. The target firm has a significant amount of cash on its balance sheet. Under a scenario where the acquirer seeks to minimize the cash outlay from its own funds, which of the following acquisition structures would be most advantageous?
- AA cash acquisition where the target's cash is used to finance part of the purchase price.
- BA leveraged buyout (LBO) of the target.
- CA cash acquisition financed entirely by the acquirer's existing cash.
- DA stock-for-stock merger.
Show answer & explanationAnswer & explanation
Correct answer: A. A cash acquisition where the target's cash is used to finance part of the purchase price.
If the target firm has significant cash, using that cash to finance part of its own acquisition (often referred to as 'bootstrapping' or 'cash out of the target') directly reduces the acquirer's required cash outlay. This is a common strategy in certain M&A deals.
Why the other options are wrong
- B. An LBO typically uses a high proportion of debt, not necessarily the target's existing cash to *finance* the purchase price, although the target's assets might secure the debt.
- C. This would maximize the acquirer's cash outlay, which is the opposite of the objective.
- D. A stock-for-stock merger uses no cash from either side for the purchase itself, but doesn't specifically leverage the target's cash for the purchase price.
Target Cash in M&A
In an acquisition, cash held by the target company can be used to finance part of its own purchase, reducing the acquirer's required cash outlay.
- Reduces acquirer's cash burden.
- Can be seen as 'bootstrapping' the acquisition.
- Affects the pro forma balance sheet of the combined entity.
Memory trick: Funding Fusions: Cash, Stock, or Smart Moves.