Merger and acquisition activity is expected to top $4.3 trillion in 2015, the highest level since 2007. And if you haven't owned a stock that was acquired or that merged with another company before, it's almost certain that you'll experience it at some point in your investing career. So exactly what happens?
Here's a closer look.
When a company announces that it's being acquired or bought out, it almost always will be at a premium to the stock's recent trading price. But depending on how the deal is being paid for, how long it's expected to take to close, and any speculation about a competing offer, a few things may happen.
For example, if a stock trades for $30 today and the company announces that it's being acquired for $40 per share in cash, the stock price will shoot up to near $40 the next trading day. However, it will typically trade for a little less than $40 for some time, gradually moving closer to the full deal price as the closing date of the transaction approaches.
It can get a little more complicated if a company is being acquired with stock, or a combination of cash and stock, since the value of that stock will also fluctuate from day to day.
For example, let's say Company A and Company B both have shares trading for $30 per share. If Company A buys Company B for one share of company A and $10 in cash, meaning $40 in economic value per share, company B's stock may shoot up in similar fashion as in the all-cash transaction described in the first example.
However, there will be more volatility, depending on the market's reaction, in terms of how it sees the deal affecting Company A. If Company A's stock falls by $5 on the announcement, it would have a negative impact on the value of Company B's stock. On the other hand, if the market views the deal favorably and Company A's stock goes up $5, then Company B's stock value would also go up. There is also the impact of dilution -- i.e., the amount of new stock Company A must issue, diluting existing investors, to fund the deal.
But the market will ultimately tie the movement of Company B's stock to that of Company A until the deal closes.
There may also be some additional discount to the stock's price if the stock being acquired is set to pay a dividend between the announced date of the transaction and the closing date. Furthermore, if there's a lot of speculation that a competing offer could materialize, it may also affect the price of the stock for the company being acquired, though this is usually a very minor impact.
Different things happen when the transaction closes, depending on how the transaction is being funded. The good news is that pretty much all of the hard work happens behind the scenes, and if you hold your shares through the transaction date, you probably won't have to do anything.
If the transaction is being paid in all cash, the shares should disappear from your account on the date of closing, and be replaced with cash. If the transaction is cash and stock, you'll see the cash and the new shares show up in your account. It's pretty much that simple. (Many brokers can also walk you through the process, so if you're looking for support, visit our broker center.)
This is one of the most important things investors should understand about buyouts. If you hold shares in a taxable account, you're subject to the same tax rules for a buyout as you are to your own buying and selling activity. In other words, if a company is bought out and you've held the shares less than one year, you will owe short-term capital gains tax on your profits, and long-term gains if you've held shares for more than one year.
You will owe taxes based on these rules whether you sell the stocks before the transaction closes, or you hold until the close date and it happens automatically. It doesn't matter whether you voted for or against the transaction. Participation and profit means you owe taxes. So consider the timeline implications. If you're close to qualifying for long-term gains, it may be worth waiting to get past that one-year mark if you're ready to sell before the transaction closes, simply to lower your tax rate on the gains.
On the other hand, you'll gain a tax-loss benefit as well, if you're unfortunate to end up losing money on the deal for some reason.
If you hold shares inside an IRA, there aren't any tax consequences, because of the tax-advantaged structure of these accounts.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at firstname.lastname@example.org. Thanks -- and Fool on!