What it means
In many takeovers the buyer does not have enough cash, or prefers not to spend it. Instead it issues new securities and swaps them for the target's shares at an agreed ratio.
The target's shareholders end up owning a piece of the combined business. The most common form is a stock-for-stock deal, where the target shareholders receive a fixed number of acquirer shares for each share they own.
Other deals mix in cash, or use bonds and convertible instruments (securities that can later be swapped for shares). The mix is chosen to balance price, tax treatment and how much control existing owners are willing to give up.
Value is the tricky part because the headline price moves every day with the acquirer's share price. If the acquirer's share price rises after announcement, target holders receive more; if it falls, they receive less.
To limit this swing, deals sometimes include a collar, a range within which the exchange terms adjust to protect one side. For the acquirer, issuing securities dilutes existing owners, meaning each owner's slice of the company becomes smaller.
It also signals something to the market: a buyer paying in its own shares is sometimes seen as believing its shares are fully priced. Cash deals avoid dilution but add debt or drain reserves.
Tax and accounting also shape the choice. In many countries a deal paid mostly in shares can allow target holders to defer tax until they sell, which makes the offer more appealing.
The rules differ by country and change over time, so advisers check them for each deal.
In practice
Real-world examples.
Example
A regional software company agrees to buy a smaller rival by issuing 0.8 of its own shares for every share of the rival. The rival's owners become shareholders in the larger business and benefit from the combined growth. No cash leaves the buyer, which preserves money for product development.
Example
A manufacturing group uses a mix of $20 cash and 0.25 new shares per target share to buy a competitor. The cash portion gives target holders certainty, while the share portion lets them participate in later gains. The finance team models how many new shares will be issued so existing owners understand their dilution.
Example
An investor holds shares in a target company and sees the acquirer's price drop 15% the week after announcement. Because the deal is paid in shares, her offer value falls by roughly the same percentage on the stock part. She weighs whether to sell now or wait for the deal to close.
Formula
Calculation
Offer value per target share = (Exchange ratio x Acquirer share price) + Cash per share
Suppose the exchange ratio is 0.5 acquirer shares per target share, the acquirer trades at $60, and the deal includes $5 in cash per share. The stock part is 0.5 x 60 = $30, and adding the cash gives 30 + 5 = $35 per target share. If the target has 10,000,000 shares, the total deal value is 35 x 10,000,000 = $350,000,000. If the acquirer's share price falls to $50, the stock part becomes 0.5 x 50 = $25, the offer drops to $30 per share, and total value falls to $300,000,000.Case study
Seen in the real world.
Calder and Finch Packaging is an illustrative, fictional company that wants to acquire a smaller rival called Ardmore Containers. Calder and Finch has $15,000,000 in cash but the purchase price is $80,000,000, so it proposes to pay with a mix of cash and newly issued shares.
The board debates how many shares to issue. Issuing too many would dilute existing owners heavily, while offering too much cash would leave the company short of working capital. The finance team settles on $15,000,000 in cash and the remaining $65,000,000 in shares priced at the average of the previous 20 trading days.
Because the share price moves before closing, the team adds a collar that adjusts the exchange ratio if the price falls or rises beyond 10%. In this illustrative story, the collar proves useful when the price drops 12% and the ratio rises to keep the target holders whole.
Watch out
Common mistakes.
- Quoting the deal value using the announcement-day share price as if it were fixed, when stock-based offers change in value every day.
- Ignoring dilution, so existing owners are surprised by how much of the company they have given up.
- Assuming all merger securities are ordinary shares, when they can include bonds, preferred shares and convertible instruments.
Questions
People also ask.
What is an exchange ratio?
It is the number of acquirer shares that target holders receive for each share they own, fixed in the merger agreement.
Why would a buyer pay in shares instead of cash?
Paying in shares preserves cash, avoids new debt, and shares the risk of the deal with the target's owners.
What does a collar do?
A collar protects either side from large swings in the acquirer's share price between signing and closing by adjusting the exchange terms within agreed limits.
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