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What does cash consideration mean in mergers and acquisitions?
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What Is Cash Consideration
In mergers and acquisitions, cash consideration refers to the amount an acquiring company will pay to purchase the stocks of a target company in cash.
In other words, the acquiring company will use cash on hand or retained earnings to pay for the stocks in cash as opposed to using equity or debt instruments.
For instance, when a company offers to buy all of the outstanding stocks of another company in cash, we can say that this acquisition is based on cash consideration.
In essence, the acquiring company uses cash to purchase 100% of the outstanding shares of the target company.
Why Pay Using Cash Consideration
Companies looking to acquire others may use “cash” as a means to convince the target company’s shareholders to sell their shares.
In addition, when many companies are competitively bidding to acquire a target, offering shareholders additional compensation in cash can help the acquirer in winning the deal.
Typically, shareholders in the target company are paid a premium in cash for them to sell their stocks.
Alternative To Cash Consideration
Some transactions can be concluded in an all-cash deal where the buying entity pays the full price of the transaction in cash.
However, there are many deals where companies deliberately use other types of considerations to pay for the purchase price or to close the deal.
In mergers and acquisitions, it’s quite common to see that an acquiring company acquires the shares of a target company with stocks.
What this means is that the acquiring company offers its own stocks in exchange for the stocks held by the shareholders of the target company (stock-for-stock deal).
Another alternative to cash consideration is to use debt to finance the purchase price.
In this example, the buying company will secure debt financing from lenders and use that to pay the purchase price.
Cash Consideration Implications
What are the implications of making a purchase in cash?
Every M&A deal is different and the characteristics of the deal should be evaluated based on the unique circumstances of the deal.
The benefit of using cash to fund a transaction is that you can win competitive bids as shareholders tend to prefer cash payments to other forms of consideration.
On the other hand, shareholders who are paid in cash will need to consider the tax consequence of the transaction.
Typically, the cash consideration is a taxable event for the shareholder and every person’s tax position may be different.
Another implication of using cash to fund a deal is that you will drain a lot of cash.
If you have a lot of cash on hand that is sitting in an unproductive manner, then funding a transaction in cash may be a good way to increase your overall profitability.
However, if you need cash to fund further projects in the future, it may not be a good idea to drain all your cash to fund an M&A deal.
The impact of the cost of capital, capital structure, credit ratios, and credit ratings must be considered.
Cash Consideration Examples
Let’s look at a few examples of cash consideration in different types of transactions to better understand the concept.
The most notable example of the use of “cash consideration” is when companies are buying others in M&A deals.
To do that, Company A will use cash on hand and money available to it in its retained earnings to pay $10,000,000 to buy all the outstanding stocks of Company B.
Another example of cash consideration is in the context of real estate transactions.
When you are looking to buy a property, you can choose to pay for a property in cash without having any form of financing.
In this case, your real estate purchase will be in cash.
Consideration In Cash Takeaways
So there you have it folks!
What Is Cash Consideration
Cash consideration is one type of consideration paid by companies in the context of mergers and acquisitions (or M&A).
When a purchase transaction is structured in a way where the buying entity pays for the selling entity in cash, we’ll refer to that transaction as structured in cash consideration.
There are other types of considerations that may be viable depending on the circumstances such as stock consideration or debt consideration.
Shareholders tend to prefer cash considerations over other types of considerations as it may involve taking less risk.
Financing a transaction will require that you consider different options, such as:
- Are you going to pay in cash or will you want to issue equity
- What is your cost of debt versus your cost of equity capital
- What will your capital structure look like
- What’s the impact on your credit ratio
- How much cash do you need following the transaction to operate your business
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