Stock-for-Stock Merger: Definition, How It Works, and Example

What Is a Stock-for-Stock Merger?

A stock-for-stock merger occurs when shares of one company are traded for another during an acquisition. When, and if, the transaction is approved, shareholders can trade the shares of the target company for shares in the acquiring firm's company. These transactions—typically executed as a combination of shares and cash—are cheaper and more efficient as the acquiring company does not have to raise additional capital.

Key Takeaways:

  • A stock-for-stock merger is when shareholders trade the shares of a target company for shares in the acquiring firm's company.
  • This type of merger is cheaper and more efficient because the acquiring company does not have to raise additional capital for the transaction.
  • A stock-for-stock merger does not impact the cash position of the acquiring company.

Understanding Stock-for-Stock Mergers

There are various ways an acquiring company can pay for the assets it will receive for a merger or acquisition. The acquirer can pay cash outright for all the equity shares of the target company and pay each shareholder a specified amount for each share. Alternatively, the acquirer can provide its own shares to the target company's shareholders according to a specified conversion ratio. Thus, for each share of the target company owned by a shareholder, the shareholder will receive X number of shares of the acquiring company. Acquisitions can be made with a mixture of cash and stock or with all stock compensation, which is called a stock-for-stock merger.

Example of a Stock-for-Stock Merger

A stock-for-stock merger can take place during the merger or acquisition process. For example, Company A and Company E form an agreement to undergo a 1-for-2 stock merger. Company E's shareholders will receive one share of Company A for every two shares they currently own in the process. Company E shares will stop trading, and the outstanding shares of Company A will increase after the merger is complete when the share price of Company A will depend on the market's assessment of the future earnings prospects for the newly merged entity.

It is uncommon for a stock-for-stock merger to take place in full. Typically, a portion of the transaction is completed through a stock-for-stock merger while the remainder is completed through cash and other equivalents.

Stock-for-Stock Mergers and Shareholders

When the merger is stock for stock, the acquiring company proposes payment of a certain number of its equity shares to the target firm in exchange for all of the target company's shares. Provided the target company accepts the offer (which includes a specified conversion ratio), the acquiring company issues certificates to the target firm's shareholders, entitling them to trade in their current shares for rights to acquire a pro-rata number of the acquiring firm's shares. The acquiring firm issues new shares (adding to its total number of shares outstanding) to provide shares for all the target firm's converted shares.

This action, of course, causes the dilution of the current shareholders' equity, since there are now more total shares outstanding for the same company. However, at the same time, the acquiring company obtains all of the target firm's assets and liabilities, thus effectively neutralizing the effects of the dilution. Should the merger prove beneficial and provide sufficient synergy, the current shareholders will gain in the long run from the additional appreciation provided by the target company's assets.

Special Considerations

A stock-for-stock merger is attractive for companies because it is efficient and less complex than a traditional cash-for-stock merger. Moreover, the costs associated with the merger are well below traditional mergers.

Additionally, a stock-for-stock transaction does not impact the acquiring company's cash position, so there is no need to go back to the market to raise more capital. Taking over a company can be expensive—the acquirer may have to issue short-term notes or preferred shares if it does not have enough capital, which can affect its bottom line. Initiating a stock-for-stock merger prevents a company from taking those steps, saving both time and money.