Explain exchange ratio in mergers and acquisitions

Exchange ratio tells about the shares, which has to be issued to each individual share (target firm) by acquiring the company. Exchange ratio is an important metric in mergers and acquisitions.

Formula

The formula for exchange ratio in mergers and acquisitions is as follows −

ER = OP/SP

Here ER = Exchange ratio, OP = offer price (target share). SP = share price (Acquirer's)

Types

The types of exchange ratios are as follows −

• Fixed exchange ratio − It tells about the amount of ownership and dilution of earnings. Acquirers prefer this.

• Floating exchange ratio − It tells about the deal value. Sellers prefer this.

• Combination − a combination of both fixed exchange ratio and floating exchange ratio using caps and collars
  (In order to limit potential variability changes collars are included)

• Fixed exchange collar set maximum value and minimum value in ratio transaction
• Floating exchange collar set maximum and minimum number of shares to issued
• Walkway rights are provisions used in the deal to walk away from a transaction (if stock price falls below predetermined trading price).

Difference between fixed exchange ratio and floating exchange ratio is as follows −

• In fixed exchange ratio, shares issued are known.
• In a floating exchange ratio, the value of a transaction is known.

Fixed exchange ratio	Floating exchange ratio
Issued shares are known.	Transaction value is known.
Transaction value is unknown.	Issued shares are unknown.
This ratio is preferred by acquirers.	This ratio is preferred by sellers.

Example

If a target firm has 5000 outstanding shares with present market value of $ 10.50 an acquirer firm will pay a 20% takeover premium. Acquirer company shares trading with $ 8.25/share

ER = OP/SP

Here ER = Exchange ratio, OP = offer price (target share). SP = share price (Acquirer's)

ER = 12.50/8.25

ER = $ 1.515