Debt and leveraged mergers in new companies and holding companies

Although this may seem controversial, as we have already said, leverage in newcos is becoming increasingly common, and even more so if they are “hung” by holding companies. This is because, given the peculiar European legislation on leveraged mergers (which we will explain later), the trend that the United States brought us is the creation by large holding companies of small newcos through loans, which offer a safe investment to the holding company and a large amount of money to the newco.

To understand everything we have explained so far, we must start with the prohibition of financial assistance in articles 143.2 for SLs and 150.1 of the Capital Companies Law.

Financial assistance occurs when the acquired company advances funds, grants credit or loans, guarantees or any financial aid to a third-party acquiring company for the purchase of its shares. That is, the acquired company assumes the cost or risk of the purchase.

Without wishing to enter into legal reflections, what this regulation seeks to protect is the same as what is intended in the regulation of treasury stock: the assets and decision-making structures of the company [1].

Following this logic, everything mentioned above seems “illegal,” but it is not. Let’s see why.

[1] We find this in the recent judgment 582/2023, of April 20, of the Supreme Court: “To be able to judge whether this case falls within the scope of the legal prohibition of art. 150.1 LSC […] it is necessary to assess whether it is possible to appreciate the presence of any of the purposes of the norm ratio and whether the structural elements that we previously identified as part of the different types of prohibited financial assistance operations and businesses are present.”

Leveraged mergers are those in which the financial assistance for the purchase of the shares or interests is provided by a third party (so that there is no prohibited financial assistance). Still, the “financed” entity merges with the acquired entity so that the latter ends up assuming the debt of the acquisition with its assets [2]. It should be noted that the third party may be the acquirer’s holding company.

Let’s look at a diagram.

[2] Of course, this business has a host of particularities, such as the guarantees that must be provided to the bank. This topic can be better developed in ORTEGA VERDUGO and ESPEJO-SAAVEDRA EZQUERRA, “Claves sobre la compra apalancada y la prohibition de ayuda financial”, Estrategia inmobiliaria, No. 232, 2006.

To clarify the whole process, the acquired company will have to pay for its shares, and, therefore, the acquiring company will assume the debt with its assets and those of the acquired company; this is the key. Suppose the acquiring company’s holding company is the third party that lends the money. In that case, this parent company can buy the acquired company with a loan, which will be returned under the conditions it agreed with its subsidiary.

We find the regulation regarding leveraged acquisitions in Royal Decree-Law 5/2023 of June 28, in transposition of Directive 2006/68/EC of the European Parliament and of the Council of September 6, 2006. Within Spanish regulations, it is regulated in Article 42.

We see, therefore, how the controversial assumption we discussed when defining financial assistance (theorised in a subjective and finalistic way) is the perfect definition of the leveraged acquisition assumption. We find an antinomy between the prohibition of the assumption of financial assistance in general and the express legality (due to a rule that explicitly enables it) of this “modality” of assistance.

As we have already said, the key is the assets of the acquirer, and those of the acquired company will assume the debt. This is quite peculiar; in the end, what is happening is that the acquired company is paying for its own shares. In addition, European legislators consider that the right to mergers sufficiently protects this operation.

This operation offers us the ability to acquire a company that we would not have been able to do by our own means, and we are sure that the acquired company will be able to assume the debt. For this process, we calculate leverage ratios that serve as an indicator. In addition, if the borrower is the holding company, it manages to be outside the operation and can even apply the entire legislative framework of financial expenses (which we will not see in this article), emptying the subsidiary of content for the credit payment.

Once the loan has been settled, we find that we have acquired a company without any capital outlay, and the company itself has assumed the financial costs, which may be in favour of a third party or the parent company of the acquiring group.

In short, this process can be beneficial even for SMEs since, if they have sufficient borrowing capacity, they can acquire another company and “make it pay” the acquisition price.