Shares or cash – which is best?

It really does depend on the circumstances of the buyer, and specific considerations need to be undertaken when deciding if your business’s value is better represented by cash or equity. By TOM McKASKILL.

By Tom McKaskill

It really does depend on the circumstances of the buyer, and specific considerations need to be undertaken when deciding if your business’s value is better represented by cash or equity.

In many acquisition situations, the buyer states in what form the consideration will be made. Generally, high growth corporations like to use their shares, as these are often at a high earnings multiple.

The disadvantage for the acquirer is that the issue of new shares will dilute the existing shareholder’s equity. The alternative of using cash is preferred if the buyer is cashed up with surplus cash, but few high growth businesses are in this lucky position.

In some cases, the buyer will be somewhat indifferent to the method of payment and will allow the vendor to choose. Leaving aside tax issues, which can sometimes have a material effect due to the timing of when a capital gain might be realised, the choice may depend on the vendor’s objectives in selling out and their view of the likely price direction of the buyer’s shares.

It is fairly rare for a vendor to take an unlisted share as consideration, although it does happen where a consolidation strategy is being undertaken with the aim of listing or selling the larger entity.

Few vendors would, however, be willing to end up as a minority shareholder in an unlisted business. Not only do they not liquidate the value in their business but they end up losing effective control of what happens to that wealth in the larger entity.

Cash may be a preferred option where the vendor has little expectation of a share price increase of the buyer’s shares or where the vendor has an alternative use of the funds.

Entrepreneurs often will sell a business in order to develop, acquire or start another. Having immediate access to the cash proceeds from a sale may be more important than taking a chance on an upside in the acquirer’s fortunes. Even where the vendor had no immediate use of the cash, they may prefer to spread their investments rather than tie their sale proceeds up in shares of the acquirer.

On the other hand, the vendor might consider that shares in the acquirer have a greater potential than a retail fund. If the acquirer has a significant public listing then the vendor can always sell down later if he or she changes their mind.

One trap to watch out for is when the entrepreneur joins the corporation and is then locked in with blackout periods or possibilities of insider trading if the shares start to fall. The vendor could end up not being able to sell shares and watch the new found wealth slide away.

Some vendors take a diversified approach. They take part consideration in cash, allowing them to have ready access to cash to improve their lifestyle and perhaps to invest in a new venture. Some proceeds might then be invested in an investment portfolio to spread their risks. The remaining part might be left in shares in the acquirer where the vendor anticipates a significant increase in price.

Where the vendor already has significant wealth, taking a risk on the acquirer’s shares may not be overly important; however, if this is the major investment of the entrepreneur, then serious consideration needs to be given to securing the benefits of selling out. There is little point in swapping one risky investment for another.