By SmartRoom on Nov 26, 2018 4:11:15 PM
It’s been a record-setting year for the mergers and acquisitions market globally. Through the first nine months of 2018, the total value of these agreed-upon deals is in excess of $3.3 trillion. That’s a 39 percent increase over 2017 levels according to the Financial Times. But with each merger or acquisition, one of the key questions becomes how is this going to be paid for? Will it be in cash or stock. With merger mania on people’s minds, let’s look at the benefits and risks of these payment considerations.
Cash deals are exactly what they sound like. One firm looks at their war chest, figures out if they have enough reserves (combined with that from some strategic partners and other capital providers) to purchase an asset and goes shopping. The benefit of cash deals, according to Fox Business, is they tend to be faster and face fewer hurdles in getting the deal closed. The numbers certainly seem to validate this assertion. In an analysis for worldwide M&A deals between 1992-2017, the M&A Research Center at the University of London found that the failure rate for cash transactions was only 2.9 percent. By way of comparison, all other forms of transactions were likely to fail 4.4 percent of the time.
Another benefit of a cash transaction is it’s relatively simple when it comes to what shape the new entity will take. As The Harvard Business Review notes, “In a cash deal, the roles of the two parties are clear-cut, and the exchange of money for shares completes a simple transfer of ownership.” They go on to note that with this kind of transaction, the roles are pretty cut and dry when it comes to who will control the new organization, with the purchaser pretty much dictating everything.
But while it may seem that a cash transaction would be the easiest of options, there are certainly risks. First and foremost, there’s the issue of the financing itself. If the financing falls apart, that would certainly doom the deal. Outside of the money risks, there are additional issues including taxes. As Fox Business notes, “One major drawback of an all-cash deal is that shareholders will be on the hook to pay potential capital gains taxes -- which are likely to climb from their current levels.” For all-stock transactions, these taxes for shareholders would likely be deferred.
With all these positives related to a cash transaction, one might wonder why anyone would consider an alternative. But there are numerous benefits to stock-based transactions, where a company uses their stock as currency to purchase another company. Perhaps the biggest perk of all is that the acquiring firm is able to keep its cash reserves around for other functions. Or if they don’t have a significant amount of cash in the first place, they don’t need to borrow money from outside partners to make that deal happen.
For the shareholders of the acquired company, the benefits are significant as well. As they are paid in stock rather than cash, they can hold on to that stock and, as a result, defer any capital gains implications that would result from this buy out. Of course there is also the potential growth of the new entity and any financial rewards that may result.
From a risk standpoint, a stock transaction presents different issues as well. In a stock transaction, the risk is shared proportionately between the acquiring firm and the acquired firm. And for ownership of the acquired firm, a stock transaction also means that you’re ceding control of the direction of the company to the buyer.
In a growing economy, where access to capital remains relatively inexpensive, stock transactions have been on the decline. In fact, according to Thomson Reuters, 33 percent of all deals in the second half of 2016 included stock in the transaction. This represents a steady decline from over 50 percent just two years before. According to Dealogic, 2017 was actually the weakest year since 1995 for U.S. companies when it came to stock-based M&As.
Not all deals are an either/or. Many feature a combination of both cash and stock. There are a variety of reasons for this including access to capital, share dilution, potential competing offers and payment preferences.
In today’s robust M&A environment, there will be no shortage of transactions of both types. The only question that remains is what’s going to be the right type for both companies involved and what value this delivers to their shareholders.