Acquired financing cost

What Is Acquired Financing Cost?

Acquired financing cost refers to the expenses incurred by an acquiring company directly associated with securing the funds necessary to complete a mergers and acquisitions (M&A) transaction. These costs are a component of the broader category of corporate finance within a business combination. Unlike other direct costs of an acquisition, such as advisory or legal fees, acquired financing costs specifically pertain to the issuance of debt financing or equity financing used to fund the purchase.

History and Origin

The accounting treatment of costs associated with business combinations has evolved over time, particularly with the advent of specific accounting standards. Historically, some acquisition-related costs, including financing costs, might have been capitalized as part of the acquired assets or goodwill. However, modern accounting principles, largely codified by the Financial Accounting Standards Board (FASB) in the United States and the International Accounting Standards Board (IASB) internationally, shifted this approach.

Under current generally accepted accounting principles (GAAP), most acquisition-related costs are expensed as incurred, recognizing them as services consumed by the acquirer rather than part of the purchase consideration. This treatment became more prevalent with the issuance of FASB Accounting Standards Codification (ASC) 805, "Business Combinations," which clarified that costs of issuing debt or equity securities for an acquisition are distinct from the acquisition itself. For instance, PwC highlights that financing costs, encompassing the costs of issuing debt or equity securities, are considered separate transactions and should not be included in the consideration transferred for a business combination. Instead, they are expensed as incurred when the service is received, or treated as a reduction of the debt or equity proceeds.⁴ This ensures that the reported cost of the acquired entity accurately reflects its fair value, separate from the expenses of financing the deal.

Key Takeaways

• Acquired financing costs are expenses directly related to obtaining funds for an acquisition, such as fees for issuing debt or equity.
• These costs are distinct from the purchase price of the acquired company and other acquisition-related expenses like legal or advisory fees.
• Under GAAP, costs to issue debt reduce the debt's carrying amount on the balance sheet and are amortized as interest expense.
• Costs to issue equity reduce the proceeds received from the equity issuance.
• Proper accounting for acquired financing costs provides a clearer picture of the true cost of an acquisition and its financing structure.

Formula and Calculation

Acquired financing cost does not typically have a single, universal formula because it represents a collection of various fees. Instead, it is the sum of these individual costs. However, the impact on the financial statements is governed by specific accounting treatments.

For debt issuance costs, the general accounting impact can be thought of as:

[
\text{Net Debt Proceeds} = \text{Gross Debt Principal} - \text{Debt Issuance Costs}
]

These debt issuance costs are then amortized over the life of the debt as part of interest expense.

For equity issuance costs:

[
\text{Net Equity Proceeds} = \text{Gross Equity Raised} - \text{Equity Issuance Costs}
]

Equity issuance costs directly reduce the amount of capital recorded in shareholders' equity.

Interpreting the Acquired Financing Cost

Interpreting acquired financing costs involves understanding their impact on the acquirer's financial health and capital structure. High acquired financing costs can indicate several factors. For instance, substantial underwriting fees or loan origination fees might suggest the acquiring company is perceived as a higher credit risk, or that market conditions at the time of financing were unfavorable. Conversely, lower costs could point to a strong credit profile or highly competitive lending/underwriting environments.

These costs also affect the overall profitability of the acquisition. While acquisition-related costs, including financing costs, are often seen as necessary expenses to facilitate growth through M&A, their magnitude can erode potential returns. Analysts often scrutinize these costs to assess the efficiency of the deal execution and the financial planning involved.

Hypothetical Example

Imagine "AcquireCo" is purchasing "TargetCorp" for $1 billion. To finance this, AcquireCo decides to issue $700 million in new corporate bonds and $300 million in new common stock.

1. Debt Issuance: AcquireCo works with an investment bank to underwrite the bond offering. The underwriting fees and other direct costs (e.g., legal fees for bond documentation, SEC registration fees) for the $700 million bond issuance total $14 million. This $14 million is an acquired financing cost related to debt. According to GAAP, this amount would be recorded on AcquireCo's balance sheet as a direct reduction from the face amount of the debt, so the net debt carrying value would be $686 million. This $14 million will then be amortized over the life of the bonds, increasing the effective interest expense recognized on the income statement.
2. Equity Issuance: For the $300 million stock issuance, AcquireCo incurs $6 million in fees, including investment banking fees, legal costs, and printing costs for the prospectus. This $6 million is an acquired financing cost related to equity. This amount directly reduces the proceeds received from the equity issuance. So, while $300 million was raised, the net addition to AcquireCo's shareholders' equity would be $294 million ($300 million - $6 million).

In this example, the total acquired financing cost for AcquireCo is $20 million ($14 million from debt + $6 million from equity).

Practical Applications

Acquired financing costs are routinely encountered in various financial contexts, particularly within corporate finance and investment banking. They are a critical consideration in:

• Mergers & Acquisitions Deal Structuring: When structuring M&A deals, financial advisors and corporate executives evaluate various financing options—whether it's cash on hand, new debt, new equity, or a combination—and the associated acquired financing costs for each. These costs directly impact the overall cost of capital for the transaction.
• Financial Reporting and Compliance: Public companies must meticulously track and report acquired financing costs in their financial statements in accordance with accounting standards like GAAP or IFRS. As highlighted by Deloitte, costs of registering and issuing debt or equity securities for an acquisition are accounted for differently from other direct acquisition costs.
• ³ Valuation and Due Diligence: During the valuation process, analysts consider how financing costs affect the acquirer's post-acquisition cash flow and profitability. While not part of the consideration transferred, these costs deplete cash and impact future earnings through amortization of debt issuance costs. For example, SEC data shows that business acquisition transaction costs, which include financing costs, are frequently reported by companies.
• ² Capital Allocation Decisions: Companies deciding between different growth strategies, such as organic growth versus growth through acquisition, factor in the expected acquired financing costs. These costs influence the overall return on investment for an M&A strategy. Investment banks earn significant underwriting fees and M&A advisory fees during these processes, as noted by Mizuho Financial Group in their review of the SPAC market, indicating the prevalence and scale of these charges.

##¹ Limitations and Criticisms

While necessary, acquired financing costs present certain limitations and can draw criticism:

• Impact on Shareholder Value: High financing costs, especially for debt, can strain an acquiring company's capital structure and lead to increased leverage. If the acquired synergy or performance does not materialize as expected, the additional financial burden from these costs can erode shareholder value.
• Accounting Complexity: The distinct accounting treatment of various acquisition-related costs, including financing costs, can be complex. For instance, costs to issue debt are netted against the debt liability, while other direct acquisition costs are expensed immediately. This distinction requires careful attention to GAAP rules to ensure accurate financial reporting.
• Hidden Costs and Transparency: While direct financing costs are disclosed, there can be indirect costs or less transparent fees embedded in complex financing arrangements. Investors need to scrutinize financial statements and disclosures to fully understand the financial burden of an acquisition.
• Market Volatility: The exact amount of acquired financing costs can be subject to market conditions at the time of issuance. For instance, if interest rates rise or market demand for new equity is low, the cost of securing funds can increase unexpectedly, impacting the overall financial viability of the acquisition.

Acquired Financing Cost vs. Acquisition-Related Costs

The terms "acquired financing cost" and "acquisition-related costs" are related but distinct.

The key difference lies in their scope and accounting treatment. Acquired financing cost is a narrow type of expense directly tied to the capital-raising aspect of an M&A deal, and its accounting treatment often involves amortization or direct reduction of capital. In contrast, acquisition-related costs encompass a broader range of expenses necessary to complete the transaction, most of which are typically expensed immediately.

FAQs

What types of fees are considered acquired financing costs?

Acquired financing costs primarily include fees paid to investment banks for underwriting debt or equity securities, legal fees associated with preparing offering documents, printing costs for prospectuses, and other direct charges incurred to secure loans or issue new shares.

How are acquired financing costs treated on financial statements?

For debt, these costs are typically netted against the principal amount of the debt on the balance sheet and then amortized over the life of the debt as part of interest expense. For equity, they reduce the proceeds received from the stock issuance and are accounted for as a reduction in shareholders' equity.

Are acquired financing costs part of the purchase price of an acquisition?

No, under current accounting standards, acquired financing costs are considered separate from the purchase price (consideration transferred) of the acquired company. They are expenses incurred by the acquirer to raise capital, not payments made to the former owners of the target company.

Can acquired financing costs impact future profitability?

Yes, acquired financing costs can impact future profitability. While direct equity issuance costs reduce the capital base, debt issuance costs are amortized over the life of the debt, increasing reported interest expense on the income statement and reducing net income. Higher costs mean a greater ongoing financial burden.

How do acquired financing costs differ from other M&A transaction costs?

Other M&A transaction costs, such as advisory fees, legal fees for negotiations, and due diligence expenses, are typically expensed immediately in the period they are incurred. Acquired financing costs, specifically for debt, are often capitalized and amortized over the debt's life, or for equity, reduce the proceeds received.