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What is an Expansion?

Using capital for corporate expansion is among the most common forms of capital uses. Expansion can include new product development, equipment and facilities for increased production or expanding the work force for a greater volume of sales and increased market penetration. The sources for financing an expansion will have similar characteristics to financing at start-up. The difference is that the corporation now has a track-record and backing financials which helps increase investor confidence.

For a corporation to remain competitive and stable, it must constantly consider how it can grow and expand by offering new products, improving the efficiency of its processes, adapting its business systems, and increasing capacity. Any time a corporation decides to expand, funding will be required. If the corporation does not have the necessary cash flow to finance these expansions from its existing revenue stream, then external financing will be necessary.

Expansions require some additional risk and financial burden for the corporation as a whole. However, the long term growth potential is considered to out-weigh the negative drawbacks of additional senior debt, mezzanine debt or equity financing.

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What is a Merger & Acquisition?

Mergers and acquisitions (M&A) occur when corporations want to grow and expand their operations or market share without the risk and difficulty of internally developing the necessary business systems and infrastructure to do so. It is often quicker, simpler and cheaper to simply acquire or merge with an existing corporation in order to grow.

A merger is when two companies combine to form one new, larger corporation. An acquisition is when one corporation chooses to purchase and acquire another business by either blending it in with its existing corporate structure or by forming a new corporation that maintains some of the acquired business’s brand identify.

These terms are often made mention of in the daily news and business reports as they are a common and highly visible activity for large corporations to take part in. Mergers & acquisitions can have a significant impact on public daily life since they may affect how a company is managed, the products it offers, as well as the level of service it provides its customers.

Mergers and acquisitions can be quite complex depending on the mix of compensation that is being offered. They can be a purely cash deal, an exchange of securities or stock, as well as a combination of the two. Other financial instruments, such as mezzanine debt, may also play a roll.

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What is a Leveraged Buy-Out?

A leveraged buy-out (LBO) is when a controlling interest of a corporation is purchased through highly leveraged financing. The financing is secured by borrowing against the assets of the corporation being acquired and possibly even the assets of the company making the buyout. The advantage of a leveraged buy-out is that it allows a corporation to make a large acquisition without putting up a lot of their own capital. Leveraged buy-outs are also referred to as highly-leveraged transactions (HLT) or bootstrap transactions.

The term leverage, in finance, is often used to describe borrowing. When a corporation is described as being heavily leveraged, or highly leveraged, it is referring to the fact that the corporation has a high level of debt finance that it must repay. The reason the term leverage is used,is due to the fact that the creditors, who have provided the financing, exercise a significant amount of power over the corporation.

In a leveraged buy-out situation, significant amounts of funds have been borrowed against assets to raise the finances. As a result, the corporation is now highly-leveraged, due to the level of debt acquired. This is the main reason why the media has depicted leveraged buyouts as being “predatory” in nature. A leveraged buyout can have four strategic intents:

  • Repackaging is when private equity is used to purchase a currently public company. The purchased company is then taken private for a few years and “cleaned up” before being returned to the market as a fresh new IPO.
  • Splitting up happens when a company is deemed to be worth more if divided or sold off in pieces. An LBO occurs and then the acquired company is dismantled. This is the most feared form of LBO and is commonly seen with conglomerates.
  • Aggregation or leveraged build-ups are when a company uses an LBO to acquire a competitor and thus enhance or add to its portfolio. This is risky because the acquired company must show a return on invested capital that exceeds the cost of acquisition.
  • Employee salvation is when the management and employees of a company borrow money to save a failing company. This is the least common form of leveraged buyout because to turn a failing company around generally requires changes in management and employees.

Therefore, the positive and negative aspects of an LBO depend on which side of the fence you are on and the strategic intent of the buyout. Companies often use mezzanine debt to fund a leveraged buyout because of its lower cost when compared to equity and it’s less stringent structure when compared to senior debt.

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What are Some Typical Capital Uses?

How capital will be used plays a significant role in how the financing will be structured and what impact it will have on a corporation’s long term financial health. The uses for capital range from small asset up-grades and expansions, right up to corporate acquisitions, mergers and re-structuring. Here is a short-list of some common capital uses:

In addition to understanding the various forms of financing, how they are structured and the effect they have on a corporation’s books, understanding the various potential uses of capital also plays a significant role in management’s decisions when pursuing financing sources.

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What is a Debt Alternative?

Debt alternatives are a form of debt relief and are referred to in contemporary times as debt restructuring or forbearance. Debt restructuring allows the re-negotiation of payment terms, conditions and payment schedules in order to allow the debtor a greater chance of repaying the original principal. By relieving some of the pressure of accrued interest as well as reducing the amount paid at each installment, the creditor protects himself from a debtor at risk of defaulting on his payments and therefore increases the likelihood of having the original debt satisfied.

Debt alternatives may also be used to take advantage of lower interest rates. By taking existing debt and either renegotiating its terms or repaying its principal with funds acquired through new sources of financing, the borrowing corporation is able to reduce its cost of financing below the amount incurred due to the original agreement. A corporation may issue callable bonds which allow for such a future restructuring. The debt from those bonds may be called when necessary then replaced with the new, lower interest rate debt.

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