Mergers and acquisitions deals are a brute force in the business world that significantly affects two businesses. That said, it affects its employees, investors, leadership, directors, creditors, suppliers, and other stakeholders. What’s more, M&A deals greatly influence the company’s stocks and stock options.
In the text to follow, we will talk about M&A mergers and acquisitions, stocks, options, and how these are interrelated.
What is M&A mergers and acquisitions?
Before we move to the effects of mergers and acquisitions on stock and stock options, it is important to have a brief overview of M&As.
M&As or mergers and acquisitions is a collective term that the business fraternity uses for transactions like acquisitions, mergers, spinoffs, and divestitures. However, the term is generally used for mergers and acquisitions.
An acquisition is an M&A activity in which a business entity buys another business. The corporate identities of both companies may remain the same, while the parent company typically has the full right to use the resources of the acquired company.
A merger is a transaction in which two businesses merge to combine their resources and form a new business entity. It is important to note that companies may or may not change their names.
Stocks and options: what are they?
Stock options and stocks are two different terms but are often used interchangeably. Owning stocks in a company means that you are a partial owner of that company.
On the other hand, stock options are just simple contracts that give you the right to purchase a company’s stock within a specified time at a specified rate.
It is important to note that you can sell stocks and stock options. Understanding the difference between these is important to make more informed investment decisions.
Also, if you are preparing for a job interview for an investment banking role, it is mandatory to have a clear understanding of these terms and other investment banking questions. You can also seek help from the MNA community when making investment decisions, getting updates on the M&A market, or developing a mergers and acquisitions strategy.
Effects of M&As on stocks and options
Mergers and acquisitions, IPOs, and similar events affect stock prices; here is how.
Volatility in pre-acquisition transactions
A pre-acquisition is an activity that takes place before any M&A transaction goes official. Stock prices of the acquired or target company generally rise before an official announcement of a merger or transaction.
These types of transactions also create rumors among the stakeholders, such as investors, shareholders, etc., which ultimately create stock price volatility. Investors start speculating on the expected outcome of the transaction, and stock trading (buying or selling) takes place. It can cause fluctuation in the stock prices of both the target and the acquiring company.
Effect on the target company’s stock prices
Mergers and acquisitions greatly affect the stock prices of the target company (available for acquisition). This impact is based on various factors such as:
Industry trends
Deal terms
Target company’s financial performance before and after the agreement
Generally, the acquisitions increase the stock prices of the target company because the buying firm pays a higher amount in order to get the approval of the shareholders.
Effect on acquiring company’s stock prices
Stock prices of the acquiring company usually decrease in case of mergers and acquisitions. That is because the company has to pay the premium either with cash or debt.
If the company is paying cash, it is going to reduce the cash reserves of the acquiring firm, which will scare shareholders/investors. Investors may also believe that the company is overpaying for the target company, which will eventually lead to reduced stock prices.
If the company decides to pay using debt, it will increase the debt-to-equity ratio of the acquiring company. Shareholders may see it as a negative sign, and the stock prices may fall. However, these price falls are usually temporary.
What should shareholders/investors do in mergers and acquisitions?
When a company undergoes acquisition, people holding options, stocks, or grants can expect financial gains. However, there can be situations where they received less than expected in various M&A deals. It is important to understand the equity implications in case you (shareholders or investors) want to exit.
The best thing to do is to consider the following elements when investing in a company.
Discuss liquidation preferences. When you evaluate an investment offer from a company, be considerate about the distribution of proceeds in case of a merger or acquisition. Even if you have already invested in a company, it is wise to discuss potential scenarios. Transparent communication about overall liquidation preferences enhances trust between employees and the company.
Exercise early and consider the tax factor. Early exercise can offer tax benefits. If the acquiring company pays cash for vested shares, it results in a substantial taxable income. Early exercise may provide more favorable tax treatment based on the stock type and issuance timing. Understanding the Alternative Minimum Tax (AMT) is crucial, particularly when dealing with incentive stock options (ISOs).
Public company considerations. Public companies have different restrictions compared to private ones; these may include trading windows and regulations. It is important to note that these elements may limit your ability to sell shares immediately post-acquisition. Therefore, always consider these elements when buying stocks or options.
Summing it up
Mergers and acquisitions have a massive impact on stocks and options for investors on both sides. Target companies may experience an increase in stock prices, while buying companies may see a temporary downfall in mergers and acquisitions.
Investors should discuss liquidation preferences, exercise stock options early, and consider tax implications in mergers and acquisitions. They can also seek help from merger and acquisitions consultants in such cases.
