Basic, lesson 1 of 3
How a deal lands on the buyer's statements
On closing day the buyer's balance sheet absorbs the target's assets and liabilities, the target's equity disappears, and whatever the buyer paid shows up as cash out, new debt, or new shares.
9 min, 3 checks
1Sources and uses
Every deal starts with a two-column table. Uses is everything the money pays for: the target's equity, any target debt the buyer refinances, and fees. Sources is where the money comes from: cash on hand, new debt, and new shares. The two columns must total the same number. If they do not, the model is wrong before it starts.
| Uses | $m | Sources | $m |
|---|---|---|---|
| Purchase of target equity | 500 | New term loan | 300 |
| Advisory and legal fees | 15 | Buyer's cash on hand | 215 |
| Total | 515 | Total | 515 |
Fees on the buy side are expensed when incurred under US GAAP. They reduce cash and, through the income statement, retained earnings. They are not added to the purchase price and do not create goodwill. Fees to raise the debt are different: they are netted against the debt and amortized as interest over its life.
Check 1
Same table, but the buyer also refinances $80m of the target's existing debt with more of its own cash. The term loan stays at $300m. How much of the buyer's cash is used now, in $m?
2Combining the balance sheets
The buyer adds the target's assets and liabilities to its own, line by line. The target's shareholders' equity does not survive: the buyer paid for it, so it is eliminated. The gap between what the buyer paid and the target's net assets becomes goodwill, before any fair value adjustments, which the next lesson adds.
Worked example
Buying a target with $150m of book equity for $500m
- 1Target: assets $400m, liabilities $250m, equity $150m.
- 2Buyer pays $500m: $300m of new debt, $200m of its own cash. Ignore fees and write-ups.
- 3Goodwill is $500m minus $150m, or $350m.
- 4Buyer's assets: minus $200m cash, plus $400m of target assets, plus $350m goodwill. Net change: up $550m.
- 5Buyer's liabilities: plus $250m of target liabilities, plus $300m of new debt. Net change: up $550m.
Both sides rise by $550m and the buyer's equity does not move. The target's $150m of equity is gone, replaced by what the buyer paid for it.
Check 2
In an all-cash acquisition with no fees, what happens to the buyer's shareholders' equity on closing day?
Check 3
The same deal is paid with $500m of newly issued buyer shares instead. What happens to the buyer's equity?
Terms in this lesson: Balance sheet, Income statement, Goodwill.
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