Then, the CFO will have to choose the maturity at which he will issue the securities (short, intermediate or long term). This will depend on the risk strategy of the company. If the life of the firm’s asset (in this case the target just bought by the company) is shorter than the life of the liabilities, then the management faces a reinvestment risk, i.e. the firm will not be able to deploy the cash released by the target to achieve returns sufficient to service the liabilities. If the life of the firm’s asset is greater than the firm’s liabilities, the company faces a refinancing risk, i.e. the firm will not be able to refinance itself on favorable terms (e.g. lower interest payments). If the life of the firm’s asset is equal to the firm’s liabilities, we call it a risk-neutral maturity. Most firms do not have such a neutral structure, because of uncertainty on the asset’s life and manager’s insider information about the future of the company (and thus its risks).
The CFO will have to choose between fix and floating rates when issuing debt instruments. This depends primarily on expectations about future market interest rates and on whether the target’s returns depend on interest rates (e.g. possibility to match the type of interest rate to the type of target returns).
The problem of the currency will also influence the CFO’s choice. Regarding his hedging strategy, he will have to consider the firm’s exposure to foreign exchange rate fluctuations, but also make a good use of potential financing possibilities in global capital markets (e.g. arbitrage). The hedging strategy often reveals the management’s view on future movement of exchange rates and the future currency mix of the firm’s cash flows.
With today’s financial markets, the CFO might also use exotic instruments in order to reduce the firm’s cost of capital induced by the acquisition. There are plenty of financial instruments linked to debt, equity or FX like futures, options, swaps, FRA’s, etc. that the CFO has at disposal to optimize its cost of capital.
When choosing the financing structure, the CFO must also consider the impact on the control of the company. Issuing debt or new stocks can have a great influence on the control of the firm. An analysis must be done on: who controls the firm (creditors, actual shareholders, raiders, etc.) and how the financing structure can lead to a change of control; what are the degrees of control of the different players; and what are the triggers leading to a change of control (e.g. default on a loan covenant, preferred stock dividend, shareholder vote, etc.).
In order to analyze the most appropriate financial structure, it is often helpful to view the financing choice from different perspectives. From the investor’s point of view, the objective is to minimize the WACC and maximize the share price of the company in order to maximize the shareholder value. The creditor wants to balance its risk-return relationship and especially to minimize the risk of default. A technique often used is the so-called “6 C’s”: Cash Flow, Collateral, Capital, Conditions (economic), Course (use of funds, strategy), Character (management). An analysis from the competitor’s point of view means to compare the standard practices in the industry and the strategic position of the company versus competitors and the competitive implications of the financial structure. The CEO wants to preserve its financial flexibility, keep the firm’s financial policies and focus on firm’s strategic goals.
To summarize, many financial and strategic factors must be considered when choosing the financing structure and major stakeholders’ perspectives must be taken into account.