Share Exchange: Everything You Need to Know
A share exchange is a type of business transaction governed by statutory law in which all corporation's shares are exchanged for those of another corporation.3 min read
A share exchange is a type of business transaction governed by statutory law in which all or part of one corporation's shares are exchanged for those of another corporation, but both companies remain in existence. To move forward with a share exchange, both corporations must have their boards of directors adopt — and their shareholders agree on — a plan for the exchange.
Plan of Share Exchange
The plan of share exchange is a document that indicates:
- The name of the corporation acquiring the shares and the name of the corporation whose shares will be acquired
- The agreed-upon conditions and terms of the exchange
- The manner and basis of the share exchange
- The cash, property, shares, or obligation that will be offered by the acquiring company in exchange for the shares
- Any other provisions of the exchange
When a target company's shareholders exchange their shares for those of the acquiring company in the process of an acquisition or merger, this is known as a stock swap of equity-based assets. The shares of each company must receive an accurate valuation to determine an appropriate ratio for the swap. If an employee exercises a stock option and pays for new shares with his or her existing shares, this is also a stock swap.
The entire consideration during a merger or acquisition can be in the form of a stock swap, or it can be used in addition to a cash payment or as part of a completely new entity.
One example of a stock swap occurred in 2017 between E.I. du Pont de Nemours and Company and the Dow Chemical Company. The swap ratio for the combined entity, DowDuPont, was 1.00 for each Dow share and 1.282 for each DuPont share.
In a deal that involves only stock and no cash, the target company's stock price will fluctuate after the stock ratio terms are agreed upon by that value. The original shareholder investment is not considered a disposal by the IRS, which means that taxpayers do not need to report a gain or loss, since the cost basis of the original investment remains the same.
For employees who are engaged in a stock swap, typically the stock they already own is swapped for new shares from the new company based on the established exchange ratio. This means that the employee does not need to purchase the new shares in cash; however, this transaction may make him or her liable to pay the alternative minimum tax. It's best to consult an experienced tax adviser.
Calculating Exchange Ratio
In a stock swap during a merger or acquisition, the number of shares the acquiring company must issue for each share of the company it is acquiring is known as the share exchange ratio. This provides shareholders with the same relative value for their shares once the entities have merged. Although the asset value is the same, the dollar amount and/or the number of shares may differ. The exchange ratio is calculated by dividing the offer price for the shares of the target company by the share price of the acquiring company.
For example, let's say Firm A is acquiring Firm B, which has 1,000 outstanding stock shares trading at a price of $10. Firm A has agreed to a takeover premium of 25 percent, creating an offer price of $10.63. Firm A is trading at $5 per share.
To find the exchange ratio, we divide the $10.63 offer price by the $5 Firm A share price and get an exchange ratio of 2.125. This means that for every share of Firm B it will acquire, Firm A must exchange 2.125 of its own shares.
During a merger and acquisition transaction that is cash-only with no shares exchanged, it's not necessary to calculate the exchange ratio. Sometimes, a theoretical exchange ratio is provided; other times, this space is left blank in the valuation model. The theoretical exchange ratio is used to show what a 100-percent stock deal would look like.
After a merger and acquisitions deal is announced, a gap in valuation typically occurs between the shares of the buyer and seller. This reflects the risks involved in the transaction, such as the possibilities that shareholders will not approve the deal, that it will be blocked by the government, or that extreme market changes will result. Some investors and hedge funds take advantage of this gap, a strategy known as merger arbitrage.
If you need help with share exchange, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.