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What Is a Stock-for-Stock Merger?
A stock-for-stock merger occurs when shares of one company are traded for another during an acquisition. Shareholders can trade the shares of the target company for shares in the acquiring firm when and if the transaction is approved. These transactions are typically executed as a combination of shares and cash, and they’re cheaper and more efficient because the acquiring company doesn’t have to raise additional capital.
Key Takeaways:
- A stock-for-stock merger occurs when shareholders trade the shares of a target company for shares in the acquiring firm.
- This type of merger is cheaper and more efficient because the acquiring company doesn’t have to raise additional capital for the transaction.
- A stock-for-stock merger doesn’t impact the cash position of the acquiring company.
- Acquisitions can be made with a mixture of cash and stock or with all-stock compensation.
How a Stock-for-Stock Merger Works
An acquiring company can pay for the assets it will receive for a merger or acquisition in various ways. Acquisitions can be made with a mixture of cash and stock or with all stock compensation, which is referred to as a stock-for-stock merger.
The acquirer can pay cash outright for all the equity shares of the target company and pay each shareholder a specified amount for each share, or it can provide its own shares to the target company’s shareholders according to a specified conversion ratio. The shareholder will receive X number of shares of the acquiring company for each share of the target company owned by a shareholder.
Example of a Stock-for-Stock Merger
A stock-for-stock merger can take place during the merger or acquisition process.
Company A and Company E might form an agreement to undergo a 1-for-2 stock merger. Company E’s shareholders will receive one share of Company A for every two shares they currently own. Company E shares will stop trading, and the outstanding shares of Company A will increase after the merger is complete. The share price of Company A will depend on the market’s assessment of the future earnings prospects for the newly merged entity.
Important
It’s uncommon for a stock-for-stock merger to take place in full. A portion of the transaction is typically completed through a stock-for-stock merger, and the remainder is completed through cash and other equivalents.
Stock-for-Stock Mergers and Shareholders
The acquiring company proposes payment of a certain number of its equity shares to the target firm in exchange for all the target company’s shares when the merger is stock for stock. The offer will include a specified conversion ratio. The acquiring company issues certificates to the target firm’s shareholders, provided the target company accepts the offer.
This entitles them to trade in their current shares for rights to acquire a pro-rata number of the acquiring firm’s shares. The acquiring firm issues new shares to provide shares for all the target firm’s converted shares, adding to its total number of shares outstanding.
This action causes the dilution of the current shareholders’ equity because there are now more total shares outstanding for the same company. The acquiring company obtains all the target firm’s assets and liabilities, however, effectively neutralizing the effects of the dilution. The current shareholders will gain in the long run from the additional appreciation provided by the target company’s assets, should the merger prove beneficial and provide sufficient synergy.
What Is Outstanding Stock?
Outstanding stock is the shares a company has issued to date and that are currently owned by shareholders. The total number of a company’s outstanding shares should appear on its balance sheet.
What Is Shareholders’ Equity?
Shareholders’ equity is the remaining value of a company’s assets after accounting for and subtracting its liabilities and debts owed. Shareholders maintain a claim to equity.
What Are Preferred Shares?
Preferred shares are a percentage of ownership in the issuing company. These shareholders have a proportional claim to the company’s assets and earnings based on the number of shares they hold. They have a claim that’s superior to the assets in the event the company must liquidate, and it’s superior to that of common shareholders. They have no say in company operations, however.
The Bottom Line
Taking over a company can be expensive. The acquirer may have to issue short-term notes or preferred shares if it doesn’t have enough capital, and this can affect its bottom line. Initiating a stock-for-stock merger prevents a company from taking those steps, saving both time and money. It doesn’t impact the acquiring company’s cash position, so there’s no need to go back to the market to raise more capital.
A stock-for-stock merger is attractive for companies because it’s efficient and less complex than a traditional cash-for-stock merger. The costs associated with the merger are well below traditional mergers.
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