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What is a stock swap?

A stock swap, also called a share exchange, share-for-share exchange, stock-for-stock, occurs during an acquisition. The company doing the takeover offers its own shares, at a predetermined rate, in exchange for the shares in the company it aims to acquire.

In most mergers and acquisitions only a part of the transaction is completed with a stock swap, while the rest is covered with cash and other forms of payment.

During the initial period, each shareholder of the company being sought for a takeover will be offered a pre-determined number of shares from the predatory corporation. Before the exchange takes place, each party carefully values the company so that a fair swap ratio can be calculated.

Stock SwapShareholders of the targeted company typically reject the acquiring corporation’s initial offer.

In order to make the share exchange appealing, the acquiring company usually offers the shareholders of the other company a ‘premium’, i.e. the shares are given a higher value than that quoted on the stock exchange.

Example of a stock swap

Imagine John’s Chocolates Inc. wants to acquire a rival, Andy’s Chocolate Corp. in a stock swap.



 

John’s gives Andy’s shareholders a certain number of its own shares for each share of Andy’s stock they own.

In a 1.5-for-1 swap, an Andy’s shareholder with 100 shares would end up with 150 shares of John’s. The Andy’s Chocolates stock is cancelled, and it no longer exists as a separate entity.

The company being targeted for acquisition might use the stock swap as a strategy to resist the takeover, by claiming that the terms are unfavorable, i.e. it is a way of seeking better terms.

In most cases, when the stock swap is done, shareholders are not allowed to sell them for a set period.

Stock swaps are not exclusively used in takeovers. A corporation may use this strategy to gain a larger shareholding in another company.