What is “Types of Consideration?”
In a Mergers and Acquisitions (M&A) deal, there are several important factors that need to be considered. The first is the financial aspects of acquiring a controlling stake in the target company. The first step in an M&A deal is to determine whether to offer cash or equity to acquire the target company. Acquirers typically offer these two types of consideration in such deals.
In corporate acquisitions, the acquiring company can opt for an all-cash deal to purchase a majority of the target company shares. In such a deal, the acquiring company does not offer its own stock to the target company’s shareholders. The cash can come from the acquirer’s balance sheet, issuance of debt, secondary issuance of equity, or issuance of other securities. In the case of equity, there is a stock-for-stock swap – where the acquirer offers to exchange the stocks of the target company’s shareholders for shares in the company of the acquirer.
Key Learning Points
- In practice, most acquisition deals are a combination of the two types of consideration
- An acquirer must consider several aspects while deciding to offer cash (via debt issuance) or equity
- The typical control premium is 20% – 40% higher than the unaffected share price
Types of Consideration – Salient Features
In practice, when an acquirer decides on what type of consideration (cash or shares) to use while purchasing a company, it will be somewhere in the spectrum of all shares and all cash. Such deals are often a combination of the two types of consideration.
However, if an acquiring company wants to go in for an all-equity or shares deal, the target company shareholders become a part of the combined business.
If an acquirer pays with shares instead of cash, it will have to pay more. This is because the selling shareholders who are receiving the new shares are taking on equity risk and so they will have to be paid more – maybe 3% to 5% more than if the deal was paid by cash. However, if they pay by cash, they will have to pay 3-5% less and there is no dilution to the ownership. Further, cash is cheaper (acquirers can take on some debt – low cost of debt). So normally, an acquirer uses excess cash first and then goes to the bank and borrows some cash and pays with that. Lastly, shares are used to pay the rest of the amount.
Types of Consideration – Cash (via debt issuance) or Equity
To finance an acquisition transaction, the acquirer must consider several aspects while deciding upon the type of consideration, which includes:
- Whether to offer cash (via debt issuance) or equity (via a stock-for-stock swap)
- The acquirer must consider the cost of financing (cost of debt is cheaper than the cost of equity)
- The impact on capital structure and credit ratios
- The effect of debt financing on the post-transaction credit ratings ability of the acquirer to raise debt at the time of the deal
- The impact of equity financing on the acquirer’s post-deal earnings and ownership.
Equity Consideration and Control Premium – Example
Suppose, an acquirer is going for a controlling stake in a publicly-traded target company (by offering equity – stock-for-stock swap). It needs to go to the stock market and find the price for a minority stake in that company – termed as the “unaffected” share price. Since the acquirer wants a controlling stake, it will need to pay a bit more than the unaffected share price i.e. pay a control premium, to incentivize investors to sell their shares to the acquirer.
Given below is the calculation of the offer premium (29.3%), based on an offer price per share of $98.50 and an unaffected share price of $76.20. The offer premium is 29.3%. The typical control premium is between the range of 20% – 40% above the unaffected share price, so this offer premium looks like it is in the normal range.