Every year it seems like mergers and acquisitions occur at record pace and valuations. There have been deals worth tens of billions, and some years even trillions of dollars, as businesses constantly strive to gain or retain a competitive advantage by acquiring other entities. As with most business transactions, cash deals are highly preferred for fairly obvious reasons. Nonetheless, plenty of mergers still happen via the sale/purchase of stock. Although the same thing essentially occurs regardless of whether the deal is completed with a cash payment or a purchase of a certain percentage of shares, there are often differences in the way in which the merger ultimately unfolds. Here are some of the key differences between the two ways to close the deal:
Clarity of Ownership
One of the reasons everyone loves a cash transaction is because of its straightforward simplicity. One side hands over cash and the other side transfers its ownership interest in the company. There is rarely any question as to who owns the company and who relinquished ownership. On the other hand, with a stock merger, the number, type, or percentage of shares sold may make it a bit harder to decipher the ownership structure. For example, the shares may be shifted around to execute the merger in a way that results in the majority owners of the acquired company becoming the majority owners of the acquiring entity, which may seem like an odd outcome. Granted, this may not always be the situation, but because shares are rearranged or even reallocated, the new ownership structure could be a bit nebulous.
Allocation of Risks
Even though cash reigns supreme, there are some potential negatives to this type of deal. The major downside to a cash transaction is that the buyers in the situation are assuming all of the potential risk associated with the merger. In a stock transfer, that risk is at least allocated amongst the shareholders in relation to their proportion of shares. The goal of a merger is obviously to realize an increase in value and thus returns. But, there are obviously risks to the joining of entities that may get in the way of that, so when paying cash buyers must be prepared to accept the potential consequences.
To return to the benefits of a cash merger, of which there are no doubt many, there is a tendency for these deals to fare better performance wise, especially in the early phase of the new entity. This may be due to the lack of ambiguity surrounding the ownership transfer, it may be because the buyers are aware of the immense risk and make more diligent efforts to avoid value erosion, or it may simply be due to random good fortune. It clearly is not possible for every deal to be paid for in cash or even to be structured in a similar manner. The best option is the one that makes sense for the companies involved that will translate to success over the long term and not just at the closing table and in the beginning stages of the transition.