What is a stock swap? Definition and example
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.
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 the fictitious company 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.