Legal Definitions - exchange ratio

The exchange ratio is a crucial term in mergers and acquisitions, defining the rate at which shares of a target company are converted into shares of the acquiring company. It specifies how many shares of the acquiring company's stock a shareholder of the target company will receive for each share they own.

Here are some examples to illustrate the concept:

• Example 1: A Tech Giant Acquires a Startup

  Imagine "InnovateCorp," a large, established technology company, decides to acquire "BrightIdeas Inc.," a smaller startup known for its innovative software. The two companies agree on an exchange ratio of 0.75 shares of InnovateCorp for every 1 share of BrightIdeas Inc. This means that for every share a BrightIdeas Inc. shareholder owns, they will receive three-quarters of a share of InnovateCorp stock. If an investor held 1,000 shares of BrightIdeas Inc., they would receive 750 shares of InnovateCorp after the acquisition is complete.

• Example 2: Two Retail Chains Merge

  Consider "MegaMart," a large national retail chain, merging with "LocalGoods," a regional competitor. After extensive negotiations and valuation, they settle on an exchange ratio where shareholders of LocalGoods will receive 1.5 shares of MegaMart for each share of LocalGoods they own. This higher ratio might reflect LocalGoods' strong brand loyalty in its region or valuable real estate holdings. A LocalGoods shareholder with 500 shares would then receive 750 shares of MegaMart stock.

• Example 3: A Pharmaceutical Company Acquires a Biotech Firm

  Suppose "GlobalPharma," a major pharmaceutical company, acquires "BioDiscovery Inc.," a smaller biotech firm with promising new drug patents. The agreed exchange ratio is 0.2 shares of GlobalPharma for every 1 share of BioDiscovery Inc. This lower ratio could indicate that while BioDiscovery Inc. has potential, its current market valuation per share is significantly less than GlobalPharma's, or that GlobalPharma is paying a premium in cash alongside the stock exchange. A BioDiscovery Inc. investor holding 2,000 shares would convert them into 400 shares of GlobalPharma.