Stock Swap

What Is a Stock Swap?

A stock swap is the exchange of one equity-based asset for one more and is frequently associated with the payment for a merger or acquisition. A stock swap happens when shareholders' ownership of the target company's shares is exchanged for shares of the gaining company. During a stock swap, each company's shares must be accurately valued to determine a fair swap ratio between the two shares. A set number of shares of one company are swapped with the shares of one more as an approach to covering costs.

Stock swaps likewise happen in employee stock compensation programs (ESOPs), in which employees exchange stock that has previously vested in order to receive more stock options.

Note that a stock swap ought not be mistaken for a equity swap, which is like a interest rate swap but instead than one leg being the "fixed" side, it depends on the return of an equity index.

How a Stock Swap Works

Stock swaps can comprise the entirety of the consideration paid in a merger and acquisition (M&A) deal; they can be a portion of a M&A deal alongside a cash payment to shareholders of the target firm, or they can be calculated for both acquirer and target for a recently formed entity.

Otherwise called a stock-for-stock deal, a securing company's stock is exchanged for the stock of the acquired company at a predetermined rate. Usually, just a portion of a merger is completed with a stock-for-stock transaction, with the other expenses being covered with cash or other payment methods.

Illustration of a Stock Swap

In 2017, the Dow Chemical Company ("Dow") and E.I. du Pont de Nemours and Company ("DuPont") closed a merger where Dow shareholders received a swap ratio of 1.00 share of DowDuPont (the combined entity) for each Dow share, and DuPont shareholders received a swap ratio of 1.282 shares of DowDuPont for each DuPont share.

Note that on account of an all-stock deal, after the swap ratio terms have been agreed upon, the stock price of the target company will vacillate in value generally as per the stock swap ratio.

Likewise, for the shareholders of the target company, the IRS doesn't consider the original investment as a "removal" for tax purposes when the company is dominated. No gain or loss should be reported at deal closing. The cost basis for shareholders of the merged company will be equivalent to the original investment.

Employee Compensation Stock Swaps

One more utilization of the term stock swap happens in the more uncommon conditions of an employee who needs to exercise their stock options and transform them into shares. An employee who was a fellow benefactor or early buyer of a profoundly fruitful startup could find that they have the option to purchase many shares of the stock, however that the money required to purchase those shares is restrictive.

In such conditions, the employee might utilize the value of shares previously owned to pay for the new shares. Instead of selling those shares to raise the cash to exercise the option, the employee simply swaps out the shares to pay for the exercise of a lot more shares.

Advantage and Disadvantages of an Option-Triggered Stock Swap

A normal stock swap transaction for an employee of a partially compensated company with stock involves the exchange of stock previously owned outright with new shares from the exercise of stock options. Essentially, the employee exchanges existing shares for another set of shares at an exchange ratio.

The fundamental advantage of this swap is that the employee doesn't need to utilize cash to receive the new set of shares. The drawback is that the swap might trigger tax liabilities. An employee in this situation ought to search out a qualified individual to assist them with approving the costs and benefits of the move. The stock swap is a complex transaction best cultivated with the assistance of an adviser.

Special Considerations

At the point when an executive is conceded either a incentive stock option (ISO) or a non-qualified stock option (NSO), that employee must actually get the shares that underlie the option to cause the option to have any value.

Both NSOs and ISOs are typically conceded under the condition that the executive is forbidden from selling them or offering them since they are commanded to exchange the options for stock. These terms are written into an executive's contract.

Features

• A stock swap likewise alludes to transactions in employee stock option compensation plans where employees exchange mature stock for recently issued stock options.
• Analysts work to determine a fair swap ratio in light of the relative valuations of the companies engaged with the transaction.
• Stock swaps happen when the shares of one company are exchanged for shares of another, which could happen during the time spent a merger or acquisition.