Acquisition bridge financing by investment banks
Bridge financing has become a popular source of revenue for investment bankers" but they need to keep two things in mind: the risk this form of financing poses for both company and bank, and possible conflicts of interest. and bank,, and possible co
As recently as the mid-1960s, the role of investment bankers in mergers and acquisitions ended when a transaction was finalized; they provided advice to clients and underwrote securities. Over the last 20 years, however, investment bankers have become more actively involved in their clients' merger and acquisition activities. Some investment bankers now initiate buyouts by describing possible targets to potential bidders; others commit their own capital by taking long-term equity positions (for example, as a partner in a leveraged buyout).
Investment bankers have also begun to provide short-term loans to merger and acquisition clients. This practice, called bridge financing, has grown significantly in the last few years and now is a standard feature in many merger and acquisition announcements.1 Critics, however, have expressed concern over potential conflicts of interest. Can an investment banker, who is both a client's advisor and a short-term creditor, objectively advise that client and underwrite securities to refinance the bridge loan? This article describes how bridge loans work, analyzes the benefits and risks both to investment bankers and to their clients, and identifies several policy questions raised by this practice. THE DEVELOPMENT OF BRIDGE FINANCING
he term "bridge loan" has traditionally
been used to describe
financing provided by venture capitalists and large institutional investors to young companies prior to their going public and to companies in financial difficulties who are trying to turn around. In the mid-1980s, investment bankers began providing "mezzanine" financing to young firms, usually in the form of debt with warrants or convertible securities. Those loans offered good potential return with possible capital gains on the equity side.
During this period, investment bankers came under considerable pressure to develop new sources of revenue. The industry was suffering a longterm decline in profits from its more traditional trading and underwriting activities as a result of deregulation and increased competition. Investment bankers identified temporary financing to support the active acquisition market of the 1980s as a potential revenue source. Some acquirers were unable to get all of the permanent financing as quickly as needed from banks or securities sales. If
investment bankers could help meet that short-term need for funds, they would then be in an excellent position to assist with arranging the permanent financing-often the sale of junk bonds or the sale of the target's assets.
Investment bankers developed two techniques to help their clients meet those short-term needs. The first, used initially by Drexel Burnham, was to issue letters of comfort indicating that the investment bank was "highly confident" that the additional financing needed for a client's offer could be raised. The second technique was to issue commitment letters for short-term, or bridge, loans to be used to complete a client's financing package.
The ability of the investment banking industry...
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