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Cash Consideration

The purchase of the outstanding shares of a company using cash as the form of payment

What is Cash Consideration?

Cash consideration is the purchase of the outstanding shares of a company using cash as the form of payment. An all-cash offer is one way that an acquirer may use to acquire a stake in another company during a merger or acquisition transaction. Cash consideration is usually preferred by shareholders when they are unable to sell the company for other forms of consideration such as debt and stock.

 

Cash Consideration

 

Also, in a competitive bidding process, shareholders are more likely to accept cash consideration over other forms of payments since cash would not affect the future performance of the combined company. Another scenario where cash consideration may be accepted is when shareholders are uncertain about the viability of the deal, and the acquirer decides to offer a premium price using cash only.

 

How It Works

Cash consideration is the use of cash as a payment option in exchange for an asset or during a merger or acquisition transaction. The transaction is made solely without using other forms of financing such as debt or acquirer stock. Cash consideration may be used as a form of payment in the following two types of transactions:

 

1. Corporate acquisition

In corporate acquisitions, the acquirer can purchase the target company through an all-cash deal. It means that the acquirer will not offer stock to the shareholders of the target company, and the equity section of the balance sheet will remain unchanged. Instead, the acquirer will use cash to purchase a majority of the company’s shares.

An all-cash transaction benefits the acquirer in a competitive bidding process since the seller is more likely to consider an all-cash deal rather than other purchase offers that include debt financing. For the seller, accepting cash consideration means that they will forfeit any gains generated by the appreciation of the acquirer’s stocks.

 

2. Real estate

When purchasing real estate, the seller may offer cash consideration as the only form of payment for the transaction. It means that the transaction will not include other forms of payment such as a mortgage or debt financing. The seller of the property is likely to accept an all-cash deal over other payments methods, even if the latter are higher-priced than the former.

It is because the seller knows that the cash offer is likely to close quickly, and will receive the whole selling price at closing. The buyer must provide proof of funds during the negotiation process as an assurance to the seller that they are committed to closing the transaction.

 

Limitations of Cash Consideration

Although cash consideration is more preferred than other forms of consideration, it will result in the loss of earning power on the money due to taxation. The sale of shares of the target company is a taxable event. The target’s shareholders will need to pay a tax percentage on the amount of money received from the sale of their holding.

Even if the acquirer pays a premium price for the purchase of majority shares of the target company, the tax will eat into this payment if it exceeds the amount that the shareholders paid when they purchased the shares. It means that shareholders are better off accepting a stock-for-stock transaction since it is not a taxable event. In the case of real estate transactions, the seller will suffer tax consequences resulting from a no-mortgage interest tax deduction.

 

Alternatives to Cash Consideration

When executing a merger or acquisition transaction, the seller may offer the following forms of considerations:

 

1. Acquisition with stock

A stock-for-stock payment is a transaction where the acquirer offers to exchange all shares that shareholders hold in the target company for shares in the acquirer’s company. Shareholders prefer an all-stock payment when they do not want to pay tax on the gains generated. The tax on the profits earned is only recognized when the shareholders decide to dispose of the stake given as compensation for the target company’s shares.

The tax is calculated on the profits earned by a shareholder, which is the difference between the selling price received and the cost basis of the shares. Accepting a stock-for-stock form of payment will mean that the shareholders will not benefit from the short-term liquidity offered by an all-cash deal.

 

2. Paying with debt

An acquirer may decide to use debt as part of the financing structure for the merger or acquisition transaction. The sellers benefit from debt financing because they will be exempted from paying taxes until the debt payments have been made. Usually, before accepting a structure that includes debt, the seller must confirm that the buyer is in a stable financial condition and will not go bankrupt in the near future.

In case the seller accepts the transaction and the buyer is declared bankrupt soon after, by a court of law, the sellers would be classified among other shareholders. They will receive payments last after other senior debtholders have been paid.

 

Related Readings

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Arm’s Length Transaction
  • Definitive Purchase Agreement
  • Negotiated Sale
  • Tender Offer

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