Like all investments, the method of payment for mergers and acquisitions (M&A) plays a very significant role in whether or not making the investment at all is feasible. There are a number of methods available to pay for M&A, each with their pros and cons.
Cash: Cash is great. It’s cheap compared to other methods, it’s an instant transaction, and it’s mess-free (meaning that once it’s done, you don’t have to mess with it again). The problem is that you’re not talking about a small amount of cash. These sums are typically huge and not always available. Not many companies, much less individuals, carry around millions or billions in an easily accessible bank account.
Debt: Debt is expensive. If you’re taking out a loan or making payments over a longer period of time to the old owners, then odds are you’re paying interest. This is going to increase the cost of the purchase significantly and should be taken into consideration during the pricing process. The nice part is that debt is relatively easy to come by and is more flexible than cash when it comes to repayment plans.
Here’s a look at debt from another perspective. For companies that are deeply troubled, agreeing to accept the debt that the company has incurred is also an issue that can be accounted for in price. If a company is worth $100 but it owes $200 in debt, then agreeing to accept that debt will certainly lower or potentially eliminate the price of purchase.
Equity: It’s not unheard of to have an IPO to afford M&A. This has the same benefits and detriments as having an IPO for any other reason, except with less investor backlash. Having an IPO just for fun tends to make investors believe that the stock is overvalued and the market price will drop, making the IPO generate fewer funds and depreciating the value of existing shares.
Now, if it’s done in conjunction with M&A, often investors are more forgiving or even excited about the prospect, increasing the value of the IPO and existing shares — not a bad option if your stock can handle the extra shares outstanding.
Another way to look at equity is through a stock swap. Rather than raising money through an IPO, a corporation can be bought by swapping stock. The shareholders agree to give up their shares of stock in exchange for a set number of shares of the acquiring company’s stock.
For example, shareholders of Company A may receive 1.2 shares of stock from the acquiring company for every 1 share of stock they hold of the acquired company. This transition of ownership in stock is quite common for merger.