Dear SaaStr: Do Companies Prefer Stock Over Cash When They Acquire Startups?
It depends on how profitable the acquirer is.
All things being equal, most tech companies that are very profitable (Adobe, Microsoft, Intuit, SAP, Oracle, Google, Facebook etc) would prefer to do acquisitions with cash. Why?
- Cash is basically stuck on the balance sheet — acquisitions are one of the few ways to really use it. If you spend it on comp or hiring, your earnings go down. But if you spend it on acquisitions, it doesn’t impact your earnings from an accounting perspective. At least, not until years later if you do a markdown of goodwill. Cash acquisitions can almost be free in the short and medium term for cash-rich big companies. They don’t have to issue more shares and they are just converting one asset (cash) to another (assets and goodwill). This is hard to understand at first, but it does drive M&A up to a point.
- Cash is not dilutive. Public tech companies have to work hard to manage the annual dilution they incur from stock and equity grants. That includes any stock-based acquisitions. So if they use stock to buy a company when they could use cash for, it leads to additional dilution. They can buy back an equivalent number of shares to offset it, but that’s more complicated.
But … a tech startup with a large market cap (i.e., public market value) but that isn’t profitable or is only marginally profitable or doesn’t have a ton of cash on the balance sheet generally prefers stock. Yes, it’s dilutive — but it doesn’t consume much cash at all (only expenses). Or if they can, sometimes they will raise debt to use for cash to do acquisitions. That also avoids a lot of dilution, or at least defers it. Companies that are even just marginally profitable often at least generate enough cash to comfortably service this debt.
And for companies that have cash but not quite enough, you’ll often see cash + stock deals, like Salesforce buying Slack:
So you sort of need to ask and understand. Each acquirer is very different here, in terms of where they are on the profitability scale. The more profitable the acquirer, the more they prefer to pay cash.
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