A combination of rising and less volatile stock prices with increasing willingness to do large-cap M&A deals has boosted the use of acquiror stock as acquisition currency. According to the What's Market public merger agreements database, which summarizes all acquisitions of US reporting companies (excluding REITs and debt-only issuers) with a signing value of at least $100 million, deals using stock as a component of consideration has increased as a percentage of total public M&A activity over the last three years. As the database shows:

Because of the increasing use of stock consideration, dealmakers and their counsel should revisit the issue of market risk caused by fluctuation in the value of the stock between signing and closing. Parties to all-stock or mixed-consideration public mergers can mitigate this risk by using pricing collars in the merger agreement. This technique is discussed in depth in Practice Note, Pricing Collars: Mitigating Market Risk in Public Mergers and is also the subject of a recent memo by Law Department Panel Firm Kirkland & Ellis LLP.

As discussed in the Practice Note, a pricing collar is a provision in the merger agreement that helps protect one or both of the parties if there are significant changes in the market price of the acquiror's stock between the signing and closing. Collars can benefit both target companies and acquirors by allowing the parties to mitigate the risks imposed by fluctuations in the acquiror's stock price. If the parties agree to a certain exchange ratio and the acquiror's stock price falls between signing and closing, the acquiror may underpay. However, if the acquiror's stock price increases, the acquiror may overpay. When either or both parties to a transaction are concerned by these risks, they can provide for an adjustment to the amount of stock to be issued to the target stockholders and, if they choose, place caps or floors (or usually both) on that adjustment.

The two basic types of pricing adjustments used in public merger agreements are:

To determine market practice for pricing collars, Practical Law surveyed all public merger agreements in the What's Market database from the beginning of 2013 through the date of this Update. Out of 196 possible deals, 64 were eligible for review, as follows:

Overall, the survey found a total of 13 agreements (20.3% of the 64 stock deals) with a form of adjustment to the stock consideration to account for change in the acquiror's stock price. These were divided between eight deals that used the fixed-exchange-ratio approach and five deals with the fixed-value approach.

The 13 agreements with pricing collars, however, were not interspersed ratably among the categories of stock consideration:

In some transactions, the target and the acquiror negotiate a walk-away provision. A walk-away provision gives one or both of the parties the right to walk away from the transaction without penalty if the price of the acquiror's stock fluctuates beyond a negotiated range. Walk-away provisions are less frequently used than pricing collars and can function alongside collars or on a stand-alone basis.

The survey of 64 stock deals found eight deals with walk-away rights, six among the mixed-consideration deals and two among the all-stock deals. Most of these deals allow the acquiror to make up the shortfall if its stock price falls below the collar. They are:

One all-stock deal with a walk-away right did not include a pricing collar at all. In the Peoples Financial Services Corp./Penseco Financial Services Corporation agreement, the target company can terminate the agreement if the acquiror's stock price drops 25% from its level at signing.

Some of these transactions also condition the walk-away right on a drop in the acquiror's stock price relative to a stock market benchmark. For more detail, click through to the underlying What's Market summaries.