Mergers & Acquisitions: Consideration shares
This article considers the circumstances in which shareholders may be willing to sell their shares in exchange for shares in the acquiring company (‘consideration shares’) and some of the issues to consider. It is the second article in our series around the means of payment used in mergers and acquisitions.
The mechanics of consideration shares
The mechanics around the share for share exchange are quite simple – shareholders agree to sell their shares in return for the issue of new shares by the acquiring company. On completion, the selling shareholders transfer their shares to the acquiring company and in return receive a share certificate for shares in the acquiring company.
Consideration shares value
If we drill into the detail, however, there are a number of issues that bear scrutiny. The first is whether the price, either of the shares being transferred or of the value of the new issue of shares, needs to be stated or agreed. Here accountants and lawyers have a different perspective which can lead to different conclusions. For tax purposes, the share swap falls into a capital gains tax relief known as the ‘paper for paper’ relief where the base cost value of the sold shares can be carried into the consideration shares and therefore the value of the shares on sale need not be established. However, for the acquiring company, if it is a PLC an independent valuation may be required by company law but even if it is a private company it must state the amount paid on the new shares including any premium and it will pay stamp duty on the shares acquired from the shareholders based on the value of the shares sold.
Within the context of a share sale and purchase agreement the headline price for the target company will be clearly stated as will the means by which it is to be paid i.e., as to a specified amount in cash or the promise to pay cash (deferred payments) and in shares in the acquiring company.
It is worth noting that the usual statutory pre-emption rights on issue of shares in favour of existing shareholders do not apply to the issue of consideration shares but the articles of association and any shareholders agreement should be checked for any other agreed pre-emption rights. This can be particularly relevant where the buyer is on a buying spree using its shares as cash equivalent and it means that it can, if the articles and any shareholders agreement allow, dilute the holdings of the shareholders that have already come on board when it buys the next company on its list of targets.
Liquidity, governance and due diligence
From the selling shareholders’ perspective, taking shares in another company should be treated in the same way as any investment in a company. Where the consideration shares are traded on a recognised stock exchange, the shares will represent relatively liquid assets (although if the selling shareholder is joining the board of the acquiring company, they may be constricted to selling windows) and governance and due diligence on the company will have been done through the listing rules. For consideration shares in a private company, liquidity means having a defined exit plan and that can include options to require the purchase of the consideration shares, and options to join in shareholders on a sale to a third party (e.g. drag and tag along rights). Governance and due diligence must be examined and undertaken in particular to establish the rights attaching to the consideration shares as a proportion of the share capital of the acquiring company.
Shareholders contemplating selling their company as part of a merger should consider whether taking shares in the acquiring company is part of a new future within an enlarged group and if so whether they are willing to fold their fortunes in with the other shareholders and see what happens or whether they require some guaranteed return on the value of the shares they are selling. If employment in the new merged group is on the table, the terms of that employment may be just as important as the share sale.
If consideration shares are simply being used instead of cash to fund the purchase price, selling shareholders will need to consider carefully issues around liquidity, governance and due diligence.
In either case, where consideration shares are part of a share sale, specialist legal advice will be required and that is where we can help.
Specialist merger & acquisition legal advice
If you are looking to find out more about consideration shares including the process and implications, we have the technical expertise and breadth of experience to help. To discuss your situation with a specialist merger and acquisition legal team please call 0117 906 9400 or email email@example.com
Read the prior articles in this series here: