What Happens to the Stock of a Company Being Acquired During a Merger?

The act of one company acquiring another is a common occurrence in the business world, often driven by strategic reasoning, market consolidation, or financial gain. When a company is bought out by another much larger company, several key transformations take place concerning the stock of the acquired company. This article seeks to elucidate what happens to the stock on the day of the merger, delving into the processes of stock price adjustment, delisting, and shareholder impact, among other related concepts.

Stock Price Adjustment and Terms of the Merger Agreement

When a larger company takes over a smaller one, the most immediate change is the stock price movement of the acquired entity. The stock of the company being acquired typically sees an adjustment reflective of the agreed-upon purchase price. If the buyout price exceeds the pre-merger stock market value, the stock price of the acquired company often increases to approach this buyout price. This adjustment helps align the financial expectations of both the acquiring and acquired companies, ensuring that investors understand the current valuation of the company that is changing hands.

Example: If Company A is valued at $10 per share, and Company B, which is being acquired by Company A, is valued at $20 per share, shareholders of Company B will receive 2 shares of Company A for every share of Company B they hold. This exchange ratio is determined by both companies and is a critical component of the merger agreement.

Delisting of the Acquired Company's Shares

Upon the finalization of the merger, the shares of the acquired company are typically delisted from the stock exchange. This process is a formal recognition that the acquired company's existence as an independent entity is no longer relevant. Shareholders of the acquired company receive compensation according to the terms outlined in the merger agreement. The compensation can be purely monetary, entirely in shares of the acquiring company, or a combination of both.

Example: If the merger agreement stipulates a 50:50 split of cash and shares, each share of the acquired company might be exchanged for half a share of the acquiring company’s stock and half a cash amount. This ensures that shareholders are financially compensated and gain a stake in the larger entity.

Impact on Shareholders and Shareholder Compensation

The acquisition process also has significant implications for shareholders of the acquired company. Shareholders are given the choice of receiving compensation based on the merger deal. If the deal is structured primarily as a stock swap, holders of the acquired company's shares will receive shares of the acquiring company. If the deal is an all-cash transaction, shareholders will receive a payment in cash. Many deals offer a combination of both, allowing shareholders some degree of choice in the compensation method.

Volatility and Market Reaction

Around the merger date, there may be some volatility as traders react to the news of the acquisition. However, once the merger is completed and shares are exchanged, the stock tends to stabilize. Investors can expect the market to reflect the new reality represented by the acquisition, further solidifying the value of the shares in the acquiring company.

Conclusion: Ownership and Future Management

Once the old shares are retired, they lose their value because they no longer represent ownership in a company that exists in its initial form. The old stock becomes part of the acquiring company's assets, and the control of the acquired company transitions to the new owner. The new owner is then in charge of managing this new part of their company, which can involve rebranding, restructuring, and strategic planning.

Acquisitions can be complex, and the timeline from agreement to finalization can extend over many months or even years. Nevertheless, for the day of the merger, the process and outcomes are clear-cut and defined by the terms of the merger agreement. This article aims to provide a clear guide for understanding what happens to the stock of a company being acquired during a merger.