AFMP4
Syllabus C. Acquisitions And Mergers C4. Financing acquisitions and mergers

C4b. Share exchange 4 / 5

Syllabus C4b)

Evaluate the advantages and disadvantages of a financial offer for a given acquisition proposal using pure or mixed mode financing and recommend the most appropriate offer to be made.

Share exchange

The predator company issues its own shares in exchange for the shares of the target company and the shareholders of the target company become shareholders of the predator company.

The advantages of a share exchange to target shareholders include:

  1. Capital gains tax is delayed.

  2. The shareholders of the target company will participate in the control and profits of the combined entity.

The advantages to the predator company are that:

  1. It preserves the liquidity position of the company as there are no outflows of cash.

  2. Share exchange reduces gearing and financial risk. However, this may depend on the gearing of the target company.

  3. The predator company can bootstrap earnings per share if its price earnings ratio is higher than that of the target company.

The main disadvantages of a share exchange are that:

  1. It causes dilution in control.

  2. It may cause dilution in earnings per share.

  3. As equity shares are issued this comparatively more expensive than debt capital.

  4. The company may not have enough authorized share capital to issue the additional shares required.

  5. There is uncertainty with a share exchange where the movements in the market price may change their wealth.

Debentures, loan stock and preference shares

Very few companies use debentures, loan stock and preference shares as a means of paying a purchase consideration on acquisitions.

The main problems of using debentures and loan stock to the predator company are that:

  1. It affects gearing and financial risk.

  2. Difficulty in determining appropriate interest rate to attract the shareholders of the target company.

  3. Availability of collateral security against repayment.

The main advantages of using debentures and loan stock are that:

  1. Interest payments are a tax allowable expense.

  2. Cost of debt is cheaper than equity.

  3. Does not dilute control.

The main problems of using preference shares are that:

  1. Dividends on preference shares are fixed and not tax allowable.

  2. May not be attractive to target shareholders as preference shares carry no voting power.

  3. Preference shares are less marketable.