What is a share swap?
Share swaps are an increasingly common corporate arrangement used in the acquisition of companies. It basically involves a purchase of the target company’s shares, in exchange for shares of the acquiring company, instead of cash consideration. So instead of receiving cash, the seller of the target company receives shares of the acquirer, and consequently becomes a shareholder of the acquirer.
A share swap provides an alternative to a “pure cash” transaction, which allows the acquiring company to purchase the target company by using its own shares as a currency to leverage the acquisition based on the acquirer’s current valuation or even potential market value.
In essence, in a share swap, shares of the acquirer are used as “payment in kind”, rather than cash payment to the seller of the target.
Why are share swaps useful in M&A?
Pure share swaps or a hybrid consideration of “part cash part equity” can be extremely useful in acquisition deals. Here are some reasons.
- Conserves cash: In an acquisition, cash is usually required to pay the seller of the target company. Companies that are low on cash reserves or that prefer to conserve its cash for critical capex and operations, may consider a share swap or a mixture of cash & shares, as it reduces the total cash outlay in the transaction.
- Lower incidental costs: In an acquisition, cash is usually required to pay the owners of the target company. Acquisitions financed by debt facilities typically incur hefty costs of borrowing such as interest. Debt financing also requires time, security instruments and negatively affects the balance sheet of the acquirer. The issuance of new shares does not come with such costs to the acquirer.
- Leverage on acquirer’s valuation: Some Venture Capital backed companies command lofty valuations from a string of successful fundraising rounds. The ‘proven‘ market value of an acquirer can be used as leverage to lighten the cash outlay of the acquisition by swapping out cash with its highly valued shares.
- Leverage on preferential rights: Sometimes, the preferential rights attaching to the shares held by the latest round of investors can also be offered to the seller of the target (rather than just ordinary shares), making the share swap exchange even sweeter to the seller.
- Strategic joint venture: Share swaps are also useful for joint ventures (or mergers), especially if the sellers of the target company continue to have a strong and active role in the operations of the target.
- Advantages to seller: A share swap or a cash / equity combination can also be attractive to the seller, where the acquirer has a strong group of companies and assets in its portfolio. The seller can leapfrog into becoming a shareholder in the investment holding company, and enjoy the long-term benefits and leverage from synergies of the group. The seller can enjoy the potential upside of the acquirer company which may stand a higher chance than the target to be listed in the stock exchange.
How does a share swap work?
The acquiring company will allot and issue its shares to the shareholders of the target company in exchange for the shares of the target company, at a pre-determined swap ratio known as the fair swap ratio/exchange ratio. As a result, the target company effectively becomes a fully owned subsidiary of the acquiring company. The sellers of the target company will be issued new shares by the acquiring company and become shareholders in the acquiring company.
To understand this better, the illustration can be seen as below:
- The acquiring company agrees to issue its shares to the sellers of the target company in exchange for the target company’s shares.
- The sellers/owners of the target company will end up owning some of the acquiring company’s shares and become one of the shareholders of the acquiring company.
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This article was written by Tiffany Chin (Pupil in Chambers) and edited by Shawn Ho (Partner). Shawn leads the corporate practice group of Donovan & Ho, and has been recognised as a Notable Practitioner, whilst the firm has been recognised as a Notable Firm for Corporate and M&A by Asialaw Profiles 2020 and 2021. We are also ranked as a Recommended Firm by IFLR1000 2020 and 2021.
Our corporate practice group advises on corporate acquisitions, restructuring exercises, joint venture arrangements, shareholder agreements, employee share options and franchise businesses, Malaysia start-up founders and can assist with venture capital funds in Seed, Series A & B funding rounds. Feel free to contact us if you have any queries.
