What Does Swap Ratio Mean?
Swap ratio is the exchange ratio in which the shares of the target company are swapped for a share in the acquiring company. For example, 10 shares of the target company are exchanged for one share in the acquiring company and, in this case, the swap ratio is 10:1. This ratio largely depends on the total value of assets of the target company; though, at times, it can also depend on negotiations and the benefits that the acquiring company will be receiving by taking over the operations of the target company. Other factors that are taken into account while calculating the swap ratio include financial ratios such as earnings per share and profits after tax, size of the company, and long term debts of the target company.
Divestopedia Explains Swap Ratio
A swap ratio's rationale is to give investors the same relative value in the shares of the new company so that the investment remains relatively unaffected from an investor's perspective. Such an arrangement is essential in giving the same amount of confidence to investors even after the merger or acquisition goes through. At the same time, it is not fair for the investors of the acquiring company to offer high returns for the investors of the target company. This is why the swap ratio is kept reasonable to maintain an equilibrium between the investors of both companies. No merger or acquisition should result in an unfair transfer of wealth from one group to another, so the swap ratio is calculated after taking into account many financial factors of both companies.
A swap ratio also brings to lights many aspects of the M&A transaction between two companies. Firstly, it shows the relative size and strength of both companies. In general, if more shares of the target company are exchanged for one share in the acquiring company, then the latter is likely to be bigger and stronger. Secondly, it determines the control that each set of shareholders has on the combined company. For example, the acquiring company may have greater control over the firm if the swap ratio is high and, therefore, its Board of Directors could have a larger share in the new Board.