Delve into the mechanics of the exchange ratio, an important tool in mergers and acquisitions that calculates the number of new shares an existing shareholder will receive, maintaining the same relative value in the newly merged entities.
The exchange ratio is the relative number of new shares that will be given to existing shareholder of a company that has been acquired or that has merged with another. After the old company shares have been delivered, the exchange ratio is used to give shareholders the same relative value in new shares of the merged entity.
- The exchange ratio calculates how many shares an acquiring company needs to issue for each share an investor owns in a target company to provide the same relative value to the investor.
- The target company purchase price often includes a price premium paid by the acquirer due to buying 100% control of the target company.
- The intrinsic value of the shares and the underlying value of the company are considered when coming up with an exchange ratio.
- There are two types of exchange ratios: a fixed exchange ratio and a floating exchange ratio.
A fixed exchange ratio is fixed until the deal closes. The number of issued shares is known but the value of the deal is unknown. The acquiring company prefers this method as the number of shares is known therefore the percentage of control is known.
A floating exchange ratio is where the ratio floats so that the target company receives a fixed value no matter the changes in price shares. In a floating exchange ratio, the shares are unknown but the value of the deal is known. The target company, or seller, prefers this method as they know the exact value they will be receiving.
Excel Example:
C11=C8*(1+C9)*C10
C12=C11/B8
C13=C12/C10
An exchange ratio is designed to give shareholders the amount of stock in an acquirer company that maintains the same relative value of the stock the shareholder held in the target, or acquired company.