Exchange Ratio
Candlefocus EditorExchange ratio, also known as share exchange ratio, is a mathematical calculation and formula used to determine the number of shares that an acquiring company needs to issue for each share a previous investor owns in a target company, in order to provide the investor with the same relative value of their holding. Exchange ratios are typically used when a company is undergoing a merger with another.
The target company purchase price will often include a premium paid by the acquirer to obtain 100% control. Essentially, the premium is the extra amount paid by the acquirer to gain full ownership of the target company. As a result, the exchange ratio calculation considers both the intrinsic value of the shares and the underlying value of the company when determining how many of the acquiring company’s shares need to be issued.
There are two main types of exchange ratios: a fixed exchange ratio and a floating exchange ratio.
Fixed Exchange Ratio
A fixed exchange ratio is often used when the price and terms of the merger are known in advance. This type of ratio is more common in public companies and often limited to an amount the acquirer is willing to pay for the target company. With a fixed ratio, the ruling company will typically choose an exchange number for all of the owners, based on what the purchase price and value of the company is considered to be worth.
For example, if a company is set to purchase 100,000 shares of a target company, and the exchange ratio is set at a value of 5:1, then the ownership stakes in the target company will be exchanged for 5 shares of the acquiring company. All the shareholders in the target company would receive 5 shares of the acquiring company at the 5 to 1 ratio, no matter what their individual ownership stake is.
Floating Exchange Ratio
A floating exchange ratio is typically used when the details of the merger between two companies are negotiated and finalized at a later date. This type of exchange ratio takes into account a variety of factors, such as the expected future value of the target company, the amount of premium the acquiring company will pay to obtain full ownership, and the type of consideration that will be offered by the acquiring company to the target company's shareholders.
For example, if a company wants to purchase 100,000 shares of a target company, but the value and premium of the target company are expected to rise within a certain period of time, the acquiring company would choose a floating exchange ratio. The exchange ratio would fluctuate over time, depending on the overall value of the target company. This type of exchange ratio allows for the exchange rate to adjust with the changing value of the target company, which helps to preserve the value of the investor's shares.
In conclusion, exchange ratio is a mathematical calculation and formula used to calculate the number of shares an acquiring company needs to issue for each share an investor owns in a target company, in order to provide the investor with the same relative value of their holding. There are two types of exchange ratios: a fixed exchange ratio and a floating exchange ratio, which takes into account a variety of factors. Exchange ratios are used to maintain the value of the investor’s shares, whether they are in the target or acquiring company.