Interest in troubled Internet giant Yahoo has not waned, it just took a break for the holidays. A group of well known Silicon Valley executives and top investment bankers are putting together a Yahoo takeover deal that would be financed largely from debt supplied by Microsoft, we’ve learned from sources with knowledge of the proposed transaction.

Under the terms of the proposed deal, the investment group would make a takeover bid for Yahoo at a relatively low premium of around 20% to its current price of around $13 per share, valuing the company at just over $20 billion.

A complicated financial structure would be put in place to finance the deal, but the bulk of the cash for the transaction would come from Microsoft as debt.

The commercial debt markets are largely closed for M&A transactions today, requiring a creative way to finance this deal. Microsoft would supply the bulk of the purchase price from their $23 billion cash hoard in return for a fixed return on the debt that is tied to Yahoo’s future cash flow. Yahoo has continued to create cash even during this crisis - that cash will be used to pay debt obligations to Microsoft.

Simultaneous to the transaction Yahoo’s search and search marketing business would be sold to Microsoft under terms similar to what Microsoft proposed in June 2008 (and nothing like the bogus reports from The Times in November).

Following the transaction the new executive team would take over the top ranks of Yahoo. A key goal of the new team would be to attempt to attract back much of the executive talent that has fled Yahoo in the last year.

This would leave Yahoo as an independent entity, albeit one closely tied to Microsoft both financially and through the search and search marketing products.

The deal, which is being characterized at this stage as a proposal to Microsoft, absolutely hinges on their involvement. It certainly brings everything the Redmond giant has asked for, namely a way to control Yahoo’s search properties without having to own the rest of the company.

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