What Happens to Stocks When Companies Merge?

When companies merge, the shares of the involved companies undergo a change, directly impacting their shareholders. This process transforms an investor’s ownership structure and value within the new combined entity. The specifics of how shares are affected, the steps shareholders must take, and the resulting tax implications vary depending on the merger’s nature and the consideration offered.

How Mergers Affect Stock Ownership

When companies combine, a shareholder’s stock can be treated in several ways, fundamentally altering their investment. The most common scenarios involve cash payments, stock exchanges, or a combination of both.

In a cash merger, shareholders of the acquired company receive a predetermined cash payment for each share they own. For example, if a company offers to buy another at $100 per share, shareholders receive $100 for each share, resulting in the immediate termination of their interest in the acquired entity.

Alternatively, a stock-for-stock merger involves shareholders exchanging their shares in the acquired company for shares in the acquiring company. This exchange is governed by an “exchange ratio,” such as 0.8:1, meaning a shareholder gets 0.8 shares of the acquiring company for every one share of the target company. This results in shareholders becoming owners in the new, combined entity.

Mixed consideration mergers offer shareholders a combination of cash and stock for their shares. Shareholders might receive a certain amount of cash plus a fraction of a share in the acquiring company for each share they held. This hybrid approach provides both immediate liquidity and continued equity participation in the merged business.

In less common scenarios, such as reverse mergers, a private company acquires a public “shell” company to become publicly traded, bypassing a traditional initial public offering (IPO). When a public company merges and goes private, its shares are delisted from the stock exchange. In such cases, shareholders usually receive cash for their shares, effectively ending public trading of that stock.

Shareholder Steps During a Merger

Shareholders play an active role during a merger by responding to communications and, in some cases, participating in voting or tendering processes. Companies involved in a merger provide relevant information and updates to shareholders of both the acquiring and target companies. These communications keep investors informed about the terms, progress, and implications of the proposed transaction.

Shareholders receive official notices, such as proxy statements and tender offer documents. A proxy statement, filed with the SEC, details the merger agreement, board recommendations, and voting procedures. Shareholders may be required to vote on the merger proposal, particularly if it significantly alters the company’s structure or requires new share issuance. This voting can be done by proxy, either by mail, phone, or online, allowing shareholders to cast their vote without attending a physical meeting.

For mergers involving cash or mixed consideration, shareholders may need to “tender” their shares. A tender offer is a public proposal from an acquirer to buy shares from all shareholders at a specified price within a set timeframe. This offer is often at a premium to the current market price to incentivize shareholders to sell. Shareholders must follow instructions, including deadlines, to submit their shares for sale.

If a merger is structured as a stock-for-stock exchange, the process for shareholders is often more automatic. Shares in the acquired company are exchanged for shares in the acquiring company directly within brokerage accounts. Shareholders do not need to take explicit action to receive their new shares, as the exchange is handled by the brokerage firm based on the announced exchange ratio. Missing deadlines for tendering shares or failing to provide voting instructions, if required, can have consequences, potentially leading to delays in receiving consideration or forfeiting certain rights.

Tax Considerations for Shareholders

Mergers can trigger various tax implications for individual shareholders, depending on how the transaction is structured. A primary distinction is whether the merger constitutes a taxable event or a tax-deferred reorganization.

Cash mergers are taxable events for shareholders. When shareholders receive cash for their shares, they realize a capital gain or loss, which is the difference between the cash received and their original cost basis in the shares. This gain or loss must be reported in the tax year the merger occurs.

Conversely, stock-for-stock mergers can qualify as tax-deferred reorganizations under Internal Revenue Code Section 368. Shareholders may not recognize an immediate capital gain or loss on the exchange of shares. Instead, the tax basis of their original shares in the acquired company is carried over to the new shares received in the acquiring company. Capital gains taxes are postponed until the new shares are eventually sold.

Capital gains and losses are calculated based on the difference between the sale price (or value of consideration received) and the shareholder’s adjusted cost basis in the stock. Shareholders receive Form 1099-B from their brokerage firm, which reports the proceeds from the merger transaction to the Internal Revenue Service (IRS). Shareholders should consult with a qualified tax professional to understand the specific tax consequences of a merger on their individual financial situation.