Sources and Uses: How a Deal Is Funded, Rupee for Rupee

A sources and uses statement sets out every rupee a transaction needs and every rupee funding it, and the two totals are equal by construction. On the buyout of Sankalp Industrial Systems Limited, invented, both sides total Rs 27,20,00,00,000. The price of the shares is Rs 20,08,00,00,000 of that; the rest is a repayment, a minority bought out and fees.

The shape is easiest to see whole at household scale. A cousin in the family is buying a two room flat. The price agreed with the seller is Rs 42,00,000, and that is the number the whole household repeats to anyone who asks. Then the paperwork starts. There is stamp duty. There is a registration charge. The bank that is lending Rs 30,00,000 wants a processing fee before it will release anything. The broker wants a commission. The seller has an outstanding home loan of Rs 8,00,000 on the same flat, and the bank holding that loan will not release its charge on the property until it is repaid on the day of the transfer.

So how much money has to be in the room on the day of registration? Not Rs 42,00,000. Nobody in that story is going to hand over Rs 42,00,000 and walk out with a flat. The real number is the price plus the duty plus the charge plus the fee plus the commission, and the seller's own loan has to be settled out of the proceeds before the seller sees a rupee. On the other side of the same day, the money has to come from somewhere and every rupee of it has to be named: the bank's Rs 30,00,000, the savings the cousin has, whatever the parents put in, and the small deposit already paid three months ago that gets set against the price.

The two lists, written down one beside the other, are a sources and uses statement. The statement is not a technique but the ordinary discipline of counting what has to leave and counting what is coming in, applied to something the size of a company instead of something the size of a flat. Every transaction in every market runs on the same two lists, and the reason professionals draw them so carefully is that a transaction which is short by even a small amount on the morning of completion does not happen at all.

What is a sources and uses statement, and what is it actually for?

A sources and uses statement has two columns. One side lists every rupee the transaction has to pay out on the day it completes. The other lists every rupee that is available to pay it. The two lists are the whole object. There is no third column and, on a properly built one, there is no line called other on either side.

Sthira Capital Partners, a financial buyer, is buying the whole of Sankalp Industrial Systems Limited, a listed manufacturer of industrial valves, precision castings and the aftermarket parts and service that go with them. The entry price is struck at 8.50 times Year 0 earnings before interest, tax, depreciation and amortisation, or EBITDAA measure of what the operations threw off in a year, struck before interest, tax, depreciation and amortisation are counted, and so before any question of how the company is funded., of Rs 2,88,00,00,000. The multiple puts the enterprise value at Rs 24,48,00,00,000, and the price for all the shares comes out at Rs 20,08,00,00,000, being Rs 100.40 a share on 20,00,00,000 shares, a premium of 11.56 per cent over the unaffectedDescribes the price a share was trading at before news of an approach had reached the market. Rs 90.00. Where that structure came from and what it later returns are worked out separately. The funding of it comes apart below.

Here is the object itself. The sources and uses statement for that transaction has five lines on each side, and both sides come to Rs 27,20,00,00,000. Not approximately. Exactly. The equality is not a convention that people have agreed to observe; it is a cash identity, and it holds for the same reason the cousin cannot pay the stamp duty with money that has not arrived yet. Money cannot be spent before it is raised.

The identity gives the statement a property worth naming early. The property makes the statement useful and also makes it dangerous. Because the two sides must agree, every change on one side forces a change somewhere else. A use added has to be matched by a source found. A source taken away means something on the uses side has to go, or another source has to grow to cover it. Because the arithmetic will not permit it, nothing on a sources and uses statement is free and nothing on it can be quietly ignored.

The two smallest uses in that drawing are the ones a reader skips, and they repay a look before going on. Financing fees of Rs 32,00,00,000 sit beside Rs 20,00,00,000 for advice, and 1.91 per cent of the transaction is what the pair comes to. At the scale of the bar they are hairlines. The two fee lines are also the exact amount by which the buyer's own money runs ahead of what the buyer's stake is worth once completion has happened, a point taken up further on.

What has to be on the uses side, and what is the test?

The test is short and it has nothing to do with value. A use is anything the transaction has to pay for on the day it completes. Not anything that is worth something. Not anything the buyer wants. Anything a cheque has to be written for, to somebody, on that day.

Applied to this transaction the test produces five lines and no more. A use on a statement like this is always cited by its number rather than by a description, so here they are, numbered.

Check the arithmetic. A numbered list exists so that somebody can. Run a finger down the rupee column and uses 1 to 5 land on Rs 27,20,00,00,000. Now look at the third column, rounded to two decimal places for display: five roundings do not have to cancel, and here they do not, so the five printed shares reach 100.01. The total row says 100.01 for that reason. Shaving a figure until a column looks tidy would have hidden a rounding behind a fiction, and the rupee column is the one that actually checks.

The exclusions teach more than the inclusions, so notice what the test excludes. The buyer is going to spend money on integration, on new systems and on a plant upgrade in the second year. None of that is a use. None of it is paid on the day of completion. The buyer has also negotiated hard for months and burned real time doing it. The months of negotiation are not a use either. And the buyer expects the business to need working capital next year. Not a use. A sources and uses statement covers one day, and the discipline of that single day is what keeps it from turning into a wish list.

Is the price of the shares the biggest question on the list?

Use 1 is the biggest line. It is rarely the biggest question. Use 1 is Rs 20,08,00,00,000, or 73.82 per cent of everything the buyer has to find. A share that size sounds like it should dominate the discussion, and in the negotiation it does. On the statement it takes the least work. By the time a statement is being drawn the price has been settled and there is nothing left to decide about it. The figure is simply written down.

The other four lines are where statements go wrong, and they go wrong in a particular direction. Use 1 is the only one of the five that anybody argued about, so it is the only one that everybody remembers. The remaining Rs 7,12,00,00,000, being 26.18 per cent of the funding, arrives quietly out of the structure of the company rather than out of a negotiation, and quiet lines are the ones that get left off.

Two of them, uses 2 and 3, are there because of what the balance sheet was already carrying on the day. Two of them, uses 4 and 5, exist because of the transaction itself. None of the four is a matter of opinion, and none of the four appears anywhere in a price per share. Take them one at a time.

What happens to the borrowing that is already there?

Sankalp Industrial Systems Limited already has Rs 6,00,00,00,000 of gross borrowing. The borrowing sits across three separate arrangements, and a lender's rights under those arrangements are set out in documents signed long before anybody thought about a change of controlThe moment at which the party able to direct a company becomes a different party.. So a buyer arriving at the company has a fork in front of it, and the fork is one of the two or three decisions that genuinely change the shape of the statement.

Branch one is refinancingPaying an existing lender out on completion day and putting fresh borrowing in its place.. The buyer repays the whole Rs 6,00,00,00,000 on the day of completion, at its carrying valueWhere an item already sits in the books, a bookkeeping fact and not an opinion about worth., and replaces it with new borrowing on the buyer's own terms. The old lenders are paid out in full and take no premium at all for the change of control; a lender is entitled to its money, not to a share of what somebody paid for the company. On this transaction the buyer takes branch one, and use 2 is Rs 6,00,00,00,000 for that reason.

Branch two is assumed debt. The borrowing simply stays where it is. Nobody pays it out, nobody refinances it, and the company carries on servicing it the day after completion exactly as it did the day before. In that case nothing has to be paid for the borrowing on the day, so there is no use 2 at all. Follow that through and the whole statement shrinks: uses fall from Rs 27,20,00,00,000 to Rs 21,20,00,00,000, and the sources have to fall by exactly the same Rs 6,00,00,00,000. The new borrowing that was going to repay the old borrowing is no longer needed.

The thing readers most often get wrong about that fork matters far beyond this case. Neither branch changes what the business costs. The enterprise value is Rs 24,48,00,00,000 on branch one and Rs 24,48,00,00,000 on branch two. The borrowing is part of the price of the business whether the buyer repays it or inherits it. The size of the funding exercise changes. The size of the purchase does not. A statement that is Rs 6,00,00,00,000 smaller is not a cheaper deal; it is the same deal with one obligation left alone.

Why is a minority stake a separate line rather than part of the price?

Because it is a separate claim held by a separate party who has to be paid separately. Sankalp Industrial Systems Limited has a subsidiary, Sankalp Coatings Private Limited, invented, of which it holds 75.0 per cent. The other 25.0 per cent is held by a different party, and that party holds no share at all in Sankalp Industrial Systems Limited. Buying every share of the parent does not buy that stake. The stake sits there afterwards, held by a party who never sold anything, unless a separate cheque is written for it.

On this transaction the buyer wants the whole of the subsidiary, so use 3 buys that 25.0 per cent out at its carrying value of Rs 60,00,00,000. Use 3 is a small line, 2.21 per cent of the funding, and its smallness is precisely why it is one of the two lines most commonly left off a statement altogether.

The household version is easy to feel. Two brothers hold a shop between them, seventy five and twenty five. A buyer negotiates with the elder brother, agrees a price for his share, and turns up on the day expecting to walk into the shop as the sole holder. The younger brother is still standing there with a quarter of it, and he was never part of the conversation. A claim that was not bought does not disappear because nobody counted it.

Where do the fees go, and who actually pays them?

Two lines, Rs 52,00,00,000 between them, and they behave differently from every other line on the statement.

Use 4 is Rs 32,00,00,000 of financing fees. The Rs 32,00,00,000 goes to the lenders who are arranging the new borrowing. Financing fees are the cost of putting a funding package together and having it available on the day, and they are charged whether the borrowing is later repaid early or run to maturity. Use 5 is Rs 20,00,00,000 of advisory fees and other transaction costs. The advisers who worked on the transaction receive them.

Now hold the two facts about the fees together. The pair teaches more than either alone. Fees are a use, so they have to be funded like any other use. And no selling shareholder receives a rupee of either. Fees are money that leaves the transaction and buys nothing that shows up in any valuation of the business.

The second fact is the one that surprises people, so trace it. Sellers receive use 1 and nothing else. The old lenders receive use 2 and nothing else. The holder of the minority receives use 3 and nothing else. Uses 4 and 5 go to two sets of people who are not selling anything at all. The Rs 52,00,00,000 is real money that has to be raised, and when the buyer later asks what the business would fetch, none of that Rs 52,00,00,000 is in the answer.

What has to be on the sources side, and what is the test?

The test is the mirror of the other one, and it is just as unforgiving. A source is anything that puts money into the transaction on the day it completes. Not anything that is worth something. Not anything the buyer expects to have later. Money, available on the day, from a named party.

Check it the same way. Down the rupee column, the five sources land on Rs 27,20,00,00,000. The uses came to the identical figure. The share column behaves the way the other one did, reaching 100.01 once each of its five entries has been cut to two decimals, and the total row is printed at what the column truly reaches rather than at a round hundred.

Two of those five sources are genuinely surprising on first encounter, and both come out of the company that is being bought rather than out of anybody's pocket. Those are sources 3 and 4, and they are worth a section each.

Does the target's own cash really count as a source?

Yes, and the reason why puts the whole logic of the sources column into place. Sankalp Industrial Systems Limited has Rs 1,20,00,00,000 of cash and cash equivalentsShort-dated holdings that can be turned into money almost at once. sitting on its balance sheet. The moment the transaction completes, the buyer controls that cash. The cash is not the seller's any more. So it can be used, on the day, to pay part of what the day costs.

The flat purchase shows the same thing. Suppose the seller had, on the day of the transfer, an advance of Rs 2,00,000 sitting with the electricity board in the seller's name that transfers with the flat and is refundable. The cousin ends up holding it. Nobody is being cheated and nobody is paying less: the price is still Rs 42,00,000. Rs 2,00,000 of what the cousin now controls simply came with the property rather than out of the savings account.

Readers reach for the wrong conclusion at exactly this point, so it is worth stopping. Using the target's cash as a source does not reduce what the sellers are paid by a single rupee. The sellers receive Rs 20,08,00,00,000 whether the buyer applies that cash or not. The cash reduces the amount the buyer has to raise from outside. And the reason it is not double counting is that the cash was already deducted when the enterprise value was converted into a price for the shares: Rs 24,48,00,00,000 became Rs 20,08,00,00,000 partly because Rs 1,20,00,00,000 of cash was added back to the sellers' side of that bridge. The cash raises the price and then funds part of it. Treating it a third time, as though it were a discount, is where the double count actually happens.

Can an asset that is going to be sold be a source before it is sold?

Source 4 is Rs 1,00,00,00,000 of non-operating assets, sold at whatever the accounts already carry them at: a surplus land parcel sitting at Rs 45,00,00,000 and a stake of 26.0 per cent in an associateHeld big enough to carry influence and too small to carry control, so its results are not added in line by line., Aruna Tooling Private Limited, invented, carried at Rs 55,00,00,000. Neither has anything to do with making valves. Neither sits inside EBITDA. Both can be sold without touching the business the buyer actually wants, and the plan is to sell them at completion and apply the proceeds.

So far so tidy. Now notice the assumption that has been smuggled in, doing more work than it looks. The statement funds Rs 1,00,00,00,000 from those assets on the strength of what they are carried at in the accounts. A carrying amount is a statement about bookkeeping and not about what anybody will pay. Carrying value is where an item already sits in the books. A buyer for a surplus land parcel is a different person with different information and an opinion of their own.

The assumption is not necessarily wrong. The transaction as locked assumes proceeds equal to carrying value, and the statement is drawn on that basis. The soft spot is worth taking away: if those two items realised Rs 80,00,00,000 rather than Rs 1,00,00,00,000, the sources column would be Rs 20,00,00,000 short and something else would have to grow to cover it. The uses would not move at all. None of the obligations care what a piece of surplus land fetched.

What about the new borrowing itself, and how much detail belongs here?

Sources 1 and 2 are the new borrowing put on the company: a senior term loan of Rs 9,00,00,00,000 and subordinated notes of Rs 4,00,00,00,000, Rs 13,00,00,00,000 between them. On the statement, those are two amounts. Two amounts are all they are, and resisting the urge to say more about them is part of the craft.

The terms each of those two arrangements demands in return, the reason one ranks ahead of the other, where the borrowing sits, how it is repaid across the years that follow and who holds what afterwards are all separate subjects, set out separately. A sources and uses statement records how much was raised, not on what terms. Blurring the two is how a clean statement turns into a muddle in which nobody can find the total any more.

One number does belong here, and it comes straight out of the sources column and nothing else. Rs 13,00,00,00,000 of borrowing against Year 0 EBITDA of Rs 2,88,00,00,000 is entry leverage of 4.51 times. Both figures are on the statement already; the ratio is just the division. Entry leverage is a size measure and says nothing whatever about whether the obligation can be met. Whether it can be met is a different subject with a different answer.

Which line is decided last, and why does that matter so much?

Source 5. The buyer's own money. Every other line on the statement is either an obligation somebody else has fixed or an amount somebody else agreed to provide, and the buyer's cheque fills whatever is left. The sponsor equity is the balancing figure for that reason.

Walk the order in which the five sources were actually settled. Uses came first, being obligations: the price was negotiated, the existing borrowing is a fact, the minority stake has a carrying amount and the fees were quoted. Rs 27,20,00,00,000 has to be found. Then sources 1 and 2: lenders decide how much they are prepared to provide and the buyer takes that as given. Then sources 3 and 4: the cash on the balance sheet is what it is and the surplus assets are what they are. Rs 15,20,00,00,000 across those four. And then, last, arithmetic: Rs 27,20,00,00,000 take away Rs 15,20,00,00,000 leaves Rs 12,00,00,00,000 of sponsor equity. Nobody chose it. It came out.

Two consequences follow, one useful and one dangerous, and both are worth carrying away.

The useful one is an identity. Hold the fees, the repayment, the minority and the four non-equity sources still, and the buyer's cheque moves one for one with the entry enterprise value. Uses sit Rs 2,72,00,00,000 above the enterprise value, that being the fees together with the cash and the assets deducted when it was struck. The remaining four sources between them supply Rs 15,20,00,00,000. Subtract a flat Rs 12,48,00,00,000 from whatever entry enterprise value is agreed and the buyer's cheque falls straight out: Rs 24,48,00,00,000 take away Rs 12,48,00,00,000 leaves Rs 12,00,00,00,000 to the rupee. The subtraction allows movement between an entry price and an equity cheque without rebuilding the statement each time.

The dangerous one is the mirror of it. Because one line absorbs everything, a statement that balances proves nothing at all about whether it is complete. Leave a use off and the balancing line simply gets smaller and the two columns still agree to the rupee. Nothing flags. No cell turns red, and no total refuses to agree. Exactly how much damage that does is set out further on.

Before that, look at what the balancing behaviour does to the shape of the funding. The uses side is fixed at Rs 27,20,00,00,000 and three of the sources are fixed at Rs 6,20,00,00,000 between them, being the notes, the cash and the assets. So the senior term loan and the sponsor equity have to come to Rs 21,00,00,00,000 between them, always. Every rupee less of one is a rupee more of the other, and the relationship is exact rather than roughly true.

What does the statement show that the price alone does not?

Three things, and each of them is invisible in a price per share.

The first is the size of the job. Rs 100.40 a share is a fact about what a seller receives. The same figure says nothing about what the buyer has to organise. The funding total is Rs 27,20,00,00,000, of which the price of the shares is Rs 20,08,00,00,000, or 73.82 per cent. The other Rs 7,12,00,00,000, being 26.18 per cent, is a repayment, a minority bought out and Rs 52,00,00,000 of fees. A quarter of the funding exercise has nothing to do with the number that was negotiated.

The second thing is the difference between the funding total and the enterprise value. The difference is Rs 2,72,00,00,000 and it decomposes exactly, with no judgement in it at all. Rs 52,00,00,000 of it is the fees. Rs 1,20,00,00,000 is the cash and Rs 1,00,00,00,000 is the non-operating assets, both of which were deducted in arriving at the enterprise value in the first place and both of which then appear again on the sources side because the buyer actually gets them. Rs 52,00,00,000 plus Rs 2,20,00,00,000 is Rs 2,72,00,00,000, and Rs 24,48,00,00,000 plus Rs 2,72,00,00,000 is Rs 27,20,00,00,000.

The third thing is the one that stays with people. Put the entry enterprise value of Rs 24,48,00,00,000 next to the Rs 13,00,00,00,000 of borrowing placed on the company, and the equity underneath is worth Rs 11,48,00,00,000 on the day the transaction completes. The buyer put in Rs 12,00,00,00,000. Fees account for that Rs 52,00,00,000 gap to the rupee, so a structure which has already paid them begins its life owing exactly that much back to itself. As a proportion of the cheque that is 4.33 per cent, and the structure carries it from the first morning. Over the five years that follow, this invented structure produced 2.40 times the money and 19.14 per cent a year, and where those two figures come from is worked out separately.

Does the same object work when the transaction is much simpler?

The same object works, and shrinking it down is the fastest way to see that the statement is general rather than a buyout technique. Take the indicative all-cash acquisition of the same company by Mahasagar Industrial Group Limited, invented, at Rs 115.00 a share. The acquirer leaves the existing borrowing exactly where it is, buys no minority out separately and funds the whole thing from new borrowing of its own.

The statement is then two lines. One use: the equity, at Rs 23,00,00,00,000, being Rs 115.00 times 20,00,00,000 shares. One source: Rs 23,00,00,00,000 of new borrowing raised by the acquirer. Two lines, one total, and exactly the same identity holding it together as the ten line version. Everything that made the buyout statement long was a feature of that structure, not of the object.