How to pay the acquisition: cash or shares?

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.

Here are some elements to think about when choosing the form of payment. When submitting an offer, the acquiring firm should consider other potential bidders and think strategic. The form of payment might be decisive for the seller. With pure cash deals, there is no doubt on the real value of the bid (without considering an eventual earnout). The contingency of the share payment is indeed removed. Thus, a cash offer preempts competitors better than securities. Taxes are a second element to consider and should be evaluated with the counsel of competent tax and accounting advisers. Third, with a share deal the buyer’s capital structure might be affected and the control of the Newco modified. If the issuance of shares is necessary, shareholders of the acquiring company might prevent such capital increase at the general meeting of shareholders. The risk is removed with a cash transaction. Then, the balance sheet of the buyer will be modified and the decision maker should take into account the effects on the reported financial results. For example, in a pure cash deal (financed from the company’s current account), liquidity ratios might decrease. On the other hand, in a pure stock for stock transaction (financed from the issuance of new shares), the company might show lower profitability ratios (e.g. ROA). However, economic dilution must prevail towards accounting dilution when making the choice. The form of payment and financing options are tightly linked (a more detailed overview on financing options will be posted at a later stage). If the buyer pays cash, there are three main financing options:

• 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.