CEVAP:

Acquiring company may use internal financing or external financing in order to finance M&A. Each alternative has its benefits and costs to consider and compare. An advantage of using internally generated funds to finance M&A is to avoid costs of external financing. However, it brings the disadvantage of increasing risks resulting from abstinence of creditors and shareholders as control mechanisms over managers’ decisions regarding the deal.

On the other hand, financing M&A externally brings advantage of control mechanism of creditors and shareholders over actions of management. Disadvantage is its costs. External financing has two options of debt financing and equity financing. If the acquirer company finances the M&A deal by largely using debt it is called as Leveraged Buyout (LBO). Sometimes debt financing may be up to 90% for a deal. Typically, the target company’s assets are used as a warranty for the loan. 

Baker and Martin (2011) emphasize that the relationship between method of payment and financing alternatives is important to understand because it also tells about how results of these two decisions will affect capital structure of acquiring firm, and also how an acquiring firm should approach to valuation of the target firm. A specific method of payment may result in certain financing alternative, or vice versa, a specific financing alternative may result in specific method of payment.