In a merger, one business buys another and takes control of its operations and finances, combining the two businesses into a single entity. Mergers occur for a number of reasons, and the goals of the two businesses involved, as well as the desires of their stockholders, impact whether a merger relies on cash or stock to complete the transaction.
In a cash merger, the acquiring business uses cash to purchase enough shares of the business it targets to take control of that business. Shares of stock entitle the buyer to vote on the board of directors and control other business decisions. In a stock merger, the acquiring business gets the stock it needs for control by exchanging shares of its own stock for stock in the target company. Stockholders for both businesses must vote on and approve both types of mergers.
Impact on Buyers
Cash and stock mergers have very different implications for acquiring businesses. A cash merger will either deplete cash reserves or force the acquirer to borrow money. In a leveraged buyout, which is a type of cash merger, the acquirer borrows money using the business it plans to acquire as collateral for the loan. Borrowing brings interest charges and risk to the acquirer. Stock mergers avoid the need to borrow or hand over cash, but they force the acquirer to pass off a level of control to the target company's stockholders, who then share ownership with the acquirer's existing stockholders.
Impact on Sellers
Businesses that find themselves targets of mergers also face different outcomes based on whether the merger involves cash or stock. Cash mergers provide the target company's stockholders with cash in exchange for their stock, removing them as investors and leaving them out of ownership in the new business. Stock mergers provide the target company's stockholders with the opportunity to profit if the new business grows in value. The details of the merger, including how much cash or stock the acquirer offers and how well investors expect the new business to perform, play important roles in the votes stockholders take to approve or deny a merger proposal.
Timing is crucial in a merger, whether it uses stock or cash as the medium of exchange. When a business proposes a cash merger, it must have sufficient cash reserves, or access to credit, to complete the deal. This means that most businesses aren't prepared to perform cash mergers after spending money on large-scale expansion or experiencing losses. Stock mergers require even more strategic timing. When a company's stock price is high, it has greater leverage in performing a stock merger and may be able to acquire the shares it needs without giving up as much of its own stock, and ownership control, as it would when its stock price is lower.
- Meeting Merger Arrows image by Scott Maxwell from Fotolia.com