Cash, Stock, and Debt Financing
An acquirer pays for a target in one of three ways: with cash, by issuing shares, or by borrowing. Each way changes who owns the combined company, how much risk it carries, and who controls it.
Paying with cash. Cash payment uses money the buyer already holds, such as cash built up from past profits. The target's owners receive a fixed amount and leave the ownership picture. The buyer's existing shareholders keep the same percentage of the company, so ownership is not diluted. The cost is that the cash is gone. It can no longer cover other needs, and the buyer has less cushion if the acquired business underperforms. Cash is simple and certain for the seller, which is why sellers often value it.
Paying with stock. Paying with stock means the buyer issues new shares and gives them to the target's owners. The target's owners become shareholders of the combined company and share in its future gains and losses. The buyer keeps its cash and takes on no new debt, but existing shareholders now own a smaller slice of a larger company. Their ownership is diluted, and control is shared with the new holders. Stock tends to suit a buyer that has little spare cash or does not want to add debt. It also lets the seller share the risk that the deal does not work out.
Paying with borrowed money. Debt financing means the buyer borrows, for example from banks or by issuing bonds, and uses the proceeds to pay the sellers. Ownership is not diluted, because lenders are owed repayment rather than given a share of the company. The trade-off is risk. The buyer must pay interest and repay the principal whether or not the acquisition performs. A heavy debt load leaves less room for error, and lenders may attach conditions that limit what management can do. Debt can therefore preserve control while increasing financial risk.
Comparing ownership, risk, and control across the three methods. The three methods can be set side by side on three questions.
- Ownership: cash and debt leave the buyer's existing shareholders with the same percentage. Stock dilutes them.
- Risk: cash lowers the buyer's reserves, debt adds fixed repayment obligations, and stock spreads the risk of the deal onto the target's former owners.
- Control: cash and debt leave control with current holders, though lenders may impose conditions. Stock gives new shareholders a voice.
No method is best in every case. The right choice depends on the buyer's circumstances, such as how much cash it holds, how much debt it can carry, and how much dilution its owners will accept.
Recommending a financing method for a hypothetical buyer. Choosing a method means matching the buyer's situation to the effects above and explaining the reasoning.
