As you invest in individual stocks, you will want to look at a company's debt burden. When companies acquire other businesses, they often take on debt to do so. In order to improve the balance sheet of the acquiring company, management might decide to "push down" some of the debt to the new company. Understanding push down accounting will help you better understand the financial situation of a business you're considering investing in or already hold in your portfolio.
Mergers & Acquisitions
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Companies buy other businesses or merge with them for a variety of reasons. A business can acquire a competitor, gaining that company's customers, technology, patents, cash, goodwill and other assets. When two companies merge, they can do it for survival, to greatly improve the profits of both businesses (as a combined, new single business) or to better compete with a larger company.
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Why Take On Debt?
In order for a tennis racquet maker to buy a tennis shoe company, the racquet maker might have to take on debt. This might be a good investment because retailers might prefer to buy more products from fewer brands/suppliers. On the other hand, the company might be in a mature position and want to diversify its product line.
Taking on $10 million in debt to buy a company that will add $4 million in profits every year is a good investment (assuming the debt push down structure is reasonable, in terms of interest, payback timing and other terms). The company will soon pay off the debt and start making the extra profits.
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Debt Push Down Accounting
The racquet company that borrows $10 million to buy the shoe company might not be in a position to take advantage of the tax deductions associated with the new debt, while the shoe company might be able to. This can occur for a number of reasons, based on whether the two companies remain separate entities, how much profit each is going to make in the next few years and other factors.
For these reasons, the management team of the acquiring team might choose to transfer some or all of the debt to the acquired company, explains business consulting firm, Rodl & Company. Rodl explains the different techniques companies can use, such as businesses using dividend payments or other methods to transfer the debt.
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Limits on This Practice
Any debt push down must leave the company taking on the debt with the ability to continue operating. If the debt cripples the acquired company and it no longer has enough capital to operate, this could run the transaction afoul of tax laws. According to accounting services firm Deloitte, debt pushdown is not an easy strategy to undertake and can create several problems for businesses that include limits on tax benefits and other issues that can vary by state.