In a transaction, once the price has been agreed by both parties, the next issue is how the total consideration should be paid, either in cash or shares (of the buying company)? From the seller’s point of view, the question is an investment issue. Should the seller reinvest the amount in the Newco (i.e. acquiring company including the target) to benefit from potential synergies and higher future value? Or should he take a cash payment in order to reinvest it other assets? The answer depends principally on the seller’s portfolio strategy, i.e. its risk and return objectives and investment constraints (liquidity, time horizon, tax concerns, legal and regulatory factors, and unique needs and preferences). From the buyer’s point of view, the form of payment is more of a financing issue. It will have an impact on its balance sheet and capital structure. However, both perspectives must be satisfied in order to have a viable deal.
- Cash on hand: it consumes financial slack (excess cash or unused debt capacity) and may decrease debt rating. There are no major transaction costs.
- Issue of debt: it consumes financial slack, may decrease debt rating and increase cost of debt. Transaction costs include underwriting or closing costs of 1% to 3% of the face value.
- Issue of stock: it increases financial slack, may improve debt rating and reduce cost of debt. Transaction costs include fees for preparation of a proxy statement, an extraordinary shareholder meeting and registration.
If the buyer pays with stock, the financing possibilities are:
- Issue of stock (same effects and transaction costs as described above).
- Shares in treasury: it increases financial slack (if they don’t have to be repurchased on the market), may improve debt rating and reduce cost of debt. Transaction costs include brokerage fees if shares are repurchased in the market otherwise there are no major costs.
In general, stock will create financial flexibility. Transaction costs must also be considered but tend to have a greater impact on the payment decision for larger transactions. Finally, paying cash or with shares is a way to signal value to the other party, e.g.: buyers tend to offer stock when they believe their shares are overvalued and cash when undervalued.
In conclusion, for the seller cash is often king, except if he believes in potential synergies and future higher value of the Newco. On the buyer’s side the mix between price, form of payment and financing must be carefully analyzed before submitting a deal structure to the target, in order to optimize the investment.