When I sold one of my businesses more than a decade ago, my M&A advisor advocated taking private stock in the acquirer as part of the consideration. At the time, they saw real value in PE-backed stock, so much so that they were willing to take their entire fee in stock rather than cash.
More than 10 years later, the opposite is true; while many advisors are now looking at stock-based deals more favorably, the ones leading the pack are more critical of the structure. Simply put, not all PE-backed equity is the same, and owners are not being as discerning about these offers as they should be.
This article discusses cash vs stock in company acquisitions; how each one works, why business owners might want them, and what people often don’t understand about them. We’ve interviewed several M&A pros for this piece to get a range of opinions.
Why Use Stock at All?
Stock-based acquisitions occur when buyers offer a seller equity in the purchased company or in the acquiring company instead of cash payment. This method is beneficial to buyers who may not have enough dry powder to purchase the company outright and for company owners who stand to benefit from long-term returns as the company rises in value over time.
Stock deals can be highly lucrative; one M&A advisor we interviewed for this piece told us that his clients often see the value of purchased stock grow by at least 3x, and as much as 9x. In several cases, clients that did a deal at the traditional 80/20 cash/stock saw their 20% stock worth more than their 80% cash a few years later. Of this advisor’s deals that involved stock, there wasn’t a single one where the stock didn’t generate 3X.
It’s worth noting that these deals all had two good things going for them: (1) a healthy auction process and (2) an M&A advisor representing the transaction, as opposed to self-representation. (Our own market data confirms the importance of the latter factor: In over 200 deals tracked over the past 24 months, self-represented owners sold their business for 31% less than those that retained an advisor.)
| Related: See our rankings of the top M&A advisory firms in the US |
The Dangers of Using Stock
Despite the success of our M&A advisor’s clients, he was careful to note that business owners can easily make the mistake of taking private equity-backed stock without understanding the value of that stock. In many cases, they even let the buyer dictate its value. The most extreme examples they provided involved scenarios where the buyer actually declined to discuss how their stock was valued, stating it was “confidential.”
Of the transactions our research team monitored between Q4 2022 and Q4 2023, approximately 75% of the offers included stock as part of the purchase price consideration, as shown in the chart below. Unlike the M&A market a decade ago, however, this stock is independently valued by the buyer, and where it lands in one buyer’s cap table is entirely different from another’s.
M&A Cash vs Stock Acquisitions (Q4 2022 – Q4 2023)
The depreciation of stock between the markets of 2013 and 2023 is a direct result of interest rates being as high as they are. Despite current interest rates hovering around 5.5% (EFFR, Q4 2023), sell-side deals are trading at the same multiples they were 18 months ago. What has changed, however, is the cap table of many PE-backed buyers, which means a seller needs to look a little deeper when it comes to accepting stock as a consideration.
In general, there are a few high-level items you want to address with each prospective buyer you are negotiating with:
- Stock Valuation: Taking on cash vs stock acquisitions is really just the business owner swapping out their stock for the stock of the acquiring company. An appropriate question, then, is “how does the acquirer value their stock?” For example, a stock valued at 20x will naturally make a more attractive offer than one valued at 10x. But does it really merit that valuation?
- Where in the Cap Table does my stock land? This can be a complex nuisance to dig into, but it plays a critical role in determining your best offer. Understanding who is on the cap table, especially who is ahead of you, helps you understand who gets their payout first should the company sell.
It’s also important to think about the number of parties involved in a sale now vs a sale 10 years ago. In the past, it was common to have two parties entitled to the proceeds of a sale: The senior lender and the common equity shareholder. Today’s market, however, has buyers still giving out their common stock with multiple investor classes in front of you, including mezzanine and sub-debt lenders, preferred equity investors, and even other common equity class holders who have more rights than you.
The chart below offers a simplified version of a traditional cap table for a company with $100MM EV in 2013 vs. what we are seeing more of today:
| Company A (2013) | Company B (2023) | ||
| Debt | $50mm | Senior Debt | $50mm |
| Class A Common Equity | $50mm | Sub debt | $10mm |
| Preferred debt | $20mm | ||
| Common equity Class A | $10mm | ||
| Common Equity Class B | $10mm | ||
It’s common to find sellers who believe that the Common A Shares in each of the above examples is worth the same. Most advisors will tell you that Company B’s Common A may have more upside, however they conveniently ignore that it also carries significantly more risk.
As a result, it has a fundamentally different value than that of Company A. For example, if both companies were to value their stock at 16x EBITDA but sell in the future for 12x EBITDA, you would see vastly different impacts on the “same” stock; Company A’s shares would be worth less than what you received for them, but Company B’s shares would be wiped out completely.
Navigating Cash vs Stock Acquisitions For Your Company
One of the most challenging experiences for business owners going through the M&A process is the extent to which relevant data is kept confidential or otherwise inaccessible. We are on a mission to provide transparency in M&A. If you are in need of advice, I’m happy to offer a few minutes to a fellow entrepreneur. You can reach me at the link below or through the contact page of this website.
