Acquisition Payment Methods

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Acquisition Payment Methods

Paying for an Acquisition With Cash

The buyer can pay the seller in cash, debt, or stock. If the seller accepts cash, then it must immediately pay income taxes on its gain. However, the seller also obtains an entirely liquid asset, and is no longer tied to the future results of its business. Generally speaking, the buyer is willing to pay less if the payment is in cash, since the buyer will have to dip into its capital resources to obtain the funds, rendering it less able to deal with other issues that may require cash funding. If the buyer goes on to achieve significant synergy gains, then its shareholders will receive the entire benefit of the gains, while the seller’s shareholders will receive no gain. Finally, the buyer may want to pay cash simply because it can, and other bidders cannot. If the buyer is cash-rich, and interest rates are so high that the cost of debt is prohibitive for other bidders, then it can make an offer that the seller literally cannot refuse.

Paying for an Acquisition with Stock

If the buyer pays in stock, the seller gains tax-deferred status on the payment (subject to the form and amount of the payment, as described in the Tax Free Acquisitions article). If the seller is in no immediate need of cash, this might make a stock payment a reasonable form of compensation. The other consideration in a stock payment is the buyer’s expectation that it will create sufficient synergies to improve the value of its stock. By paying the seller in stock, the buyer’s shareholders are foregoing some of the synergy gains to be achieved, and giving them to the seller. Conversely, if the seller suspects that it cannot achieve sufficient synergies, then it can offload some of the risk to the seller by issuing stock. Finally, if the buyer is a private company, the seller has no clear path to eventually liquidating any shares paid to it, which makes this an extremely unpalatable option.

The buyer’s payment behavior is also driven by its perception of how fairly the market is currently valuing its stock. If the buyer feels that its stock price is currently trading at a maximum level, then it will be more inclined to use its stock for acquisitions, and will act in the reverse manner if its stock is trading at a low price. If the buyer consistently uses its stock to acquire multiple companies in succession, the market may feel that this is a sign that the buyer’s management is of the opinion that the stock has reached a maximum valuation, and so will tend to trade down its price.

Paying for an Acquisition With Debt

If the buyer pays with debt, the seller is in the worst position of all three payment scenarios. The seller’s shareholders do not obtain any liquid assets in the short term, they do not share in any upside potential caused by synergy gains that would have been realized by stock ownership, and they are totally dependent on the buyer’s management team to create enough cash flow to pay them. If the seller has collateralized the assets of the sold business, this is still not adequate, since the buyer may have stripped the entity of assets by the time the seller obtains possession of it.

Summary of Acquisition Payment Methods

In short, the seller prefers cash for its liquidity value, but foregoes the opportunity to share in any synergy gains that stock ownership would have provided. The buyer prefers a cash payment if it is sure of its ability to achieve significant synergies, which it wants to retain through stock ownership. A debt payment is the worst case scenario for the seller, who obtains neither liquidity nor appreciation value. While these choices are frequently driven solely by the financing available to the buyer, this is not always the case. If the buyer has the option of paying in stock or cash, but pays in cash, then this is a significant indicator that it believes it can reserve significant synergy gains for its shareholders. If the buyer has the same option but pays in stock, then it may be more concerned with its ability to achieve synergy gains, and so is offloading some of the risk onto the seller.