Seller Debt in Acquisitions of Private Firms: A Security Design Approach

Abstract

We propose a security design model in which a potential acquirer approaches a firm with a value-add plan. The target has a single owner, who possesses private information: he alone knows whether his firm is compatible with the plan. The owner agrees that the acquirer will add value but believes that the value-add will not be as much as what the acquirer expects. Although the acquirer can choose any monotone limited liability security to offer along with cash, we show that, under general conditions, any security that is employed always takes the form of non-recourse junior debt provided by the seller.


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Keywords: Security design, private capital, private asset acquisition, asymmetric information, seller financing, screening equilibrium, tranching, disagreement

JEL Classification: G34, D86, D82, G32, G24