Fixed Dollar Value Collar

DEFINITION of 'Fixed Dollar Value Collar'

A floor and cap on the stock component of an acquisition transaction, within which the purchasing company agrees to deliver a fixed dollar value of its stock for each share of the target company. In a fixed dollar value collar, the exchange ratio i.e., the ratio at which the target company exchanges its shares for those of the acquiring company, will fluctuate within the collar, while the floor and cap fix minimum and maximum levels for the exchange ratio.

The fixed dollar value collar is one of two types of collars used in M&A transactions, and is geared toward protecting the seller or target company's interests. This is because it delivers a constant dollar value for each of the seller's shares even if the acquirer's stock price plunges. The other type of collar, the fixed number of shares collar, is more beneficial to the buyer or acquirer because it limits share dilution.

BREAKING DOWN 'Fixed Dollar Value Collar'

For example, assume BigCo announces a deal to acquire SmallFry at a 25% premium to the latter's closing price of $10, when BigCo's stock was trading at $20. The exchange ratio in this case is therefore 0.625 (i.e. $12.50 / $20). SmallFry is concerned about the possibility of BigCo's shares trading significantly lower by the time the transaction closes in three months time, since this would mean that the currency it has been paid in (i.e., BigCo shares) is worth substantially less than it was worth when the deal was announced.

SmallFry and BigCo therefore enter into a fixed dollar value collar of 10% on either side of the $20 midpoint. The floor price for this collar is therefore $18, with a cap of $22. This means that within the collar, the 0.625 exchange ratio adjusts to ensure that each SmallFry share is exchanged for $12.50 of BigCo stock.

If BigCo shares plunge and are trading at $16 when the deal is nearing completion, SmallFry shareholders would get 0.6944 (i.e. $12.50/$18) BigCo shares for each of their shares. The $18 floor ensures that SmallFry shareholders receive at least this dollar value of BigCo shares when the transaction closes.

Conversely, if BigCo shares surge and trade at $25 as the deal nears completion, the exchange ratio would be fixed at the cap level of $22, for an exchange ratio of 0.5682.

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