A company that is in the market to make an acquisition typically has several financing options. Among the choices, a deal can be paid for using all cash or the publicly traded stock of the acquiring company. Deals can also be funded with a combination of cash and stock. An acquiring company's management team may choose the desired financing method based on the amount of cash on hand coupled with the risk tolerance of the corporation.
In a cash merger, the acquirer uses cash to buy a target company. The price tag may still be expressed on a per-share basis even if it is financed with cash. Instead of exchanging shares of stock, however, the buyer uses cash that is available on a balance sheet or turns to the debt capital markets for loans. Debt increases the risk associated with the transaction because those financial obligations must be repaid. The risk becomes heightened if the target company also has debt because it is not unusual for a buyer to inherit the liabilities of the newly acquired business.
A publicly traded company may decide to make an acquisition using its own equity. The precise terms on stock deals vary but can be performed on a one-to-one basis. With this ratio, the buying company exchanges one of its own shares of stock for each one of the target company's shares. The two stocks continue to trade until the merger is finally approved by regulators and shareholders. At this time, the target company's stock ceases to trade. Investors in the target company may exchange each share for one share of the surviving company's stock.
Investors in a target company face greater tax liabilities in a deal that is financed using cash versus stock, according to the New York University Stern School of Business. Sometimes, a stock deal can also leave investors with a higher tax obligation. If a deal is financed using both cash and stock and less than 80 percent of the deal is done using equity shares, investors in the target company may be taxed, according to "The Seattle Times." Investors are taxed for the difference between the market value of the stock at the time the shares were purchased and the merger price per share.
In order for any deal to be approved it needs to win the support of shareholders, regardless of whether it is paid for using cash or stock. If a bid for a target company becomes competitive, an acquirer may be motivated to enhance the deal with a greater cash component or raising the price per share to appease shareholders. In 2011, a proposed merger between the London Stock Exchange and Canada's TMX Group failed, according to "The Globe and Mail." The deal collapsed even after the LSE improved its stock offer with a cash dividend component amid competition from another bidder.