Debt Financing

Debt financing means that a company raises money through loans or bonds instead of issuing new shares. The borrowed capital must be repaid with interest. The advantage is that existing owners keep their shares and are not diluted. An additional benefit may arise to the extent that interest is tax deductible and the resulting tax saving can be used.

The instrument range runs from classic working capital lines through investment and acquisition loans, syndicated loans and Schuldschein loans to unitranche facilities from credit funds, mezzanine capital and bonds, differing in ranking, security, tenor, amortisation and price. The cost of debt is not only interest but restricted freedom of action: security ties up assets, covenants limit investment, distributions and acquisitions, and fixed payment obligations exist regardless of earnings. That is precisely where leverage cuts both ways, because the same structure that raises return on equity in good years amplifies losses in bad ones.

In transaction practice debt is an important return driver in a buyout and, together with available equity, influences the affordable purchase price, which is why mid-market valuations respond noticeably to changes in credit markets. Sequencing matters in practice, because sustainable debt must be assessed against cash flows, risks and, where relevant, collateral. The required equity contribution follows from the purchase price, other funding needs and available debt financing. The costs of raising it also deserve attention, meaning arrangement and commitment fees, legal and advisory costs and the cost of creating security, which together account for a substantial share of transaction costs. Adequate liquidity headroom and refinancing planned early help absorb unexpected setbacks.

Note: This explanation is for general information only and does not constitute tax advice. Tax treatment depends on the individual case and may change with new legislation. For a binding assessment, please consult a qualified tax adviser.