Fixed vs Floating Exchange Ratios in M&A, and How Collars Split the Risk

In an all-stock acquisition, the buyer pays with its own shares, and the exchange ratio sets how many of them each target shareholder receives. The buyer's share price will move between signing the merger agreement and closing the deal. The structure the two sides agree for the exchange ratio decides who absorbs that move: the target's shareholders, the buyer's shareholders, or both within agreed limits. Interviewers like this topic because a memorised definition will not carry you; you have to reason through a price change in real time.

The exchange ratio in one line

Multiply the ratio by the target's share count to get the new shares the buyer issues. Divide those by the buyer's existing shares plus the new ones to get the target holders' stake in the combined company.

Take an illustrative example with round numbers. BuyCo trades at $60 and has 45 million shares outstanding. TargetCo trades at $25 and has 10 million shares, and BuyCo agrees to pay $30 per share (a 20% premium), all in stock.

Now BuyCo's stock falls 20% to $48 before closing.

Fixed exchange ratio: the share count holds, the value moves

Under a fixed exchange ratio, the parties write 0.50x into the merger agreement and it stays put. BuyCo still issues 5 million shares and TargetCo's holders still own 10%. Each TargetCo share now converts into $24 of BuyCo stock instead of $30, so the deal is worth $240 million at closing.

The target's shareholders carry the price risk, in both directions: had BuyCo risen to $72, they would have received $36 per share. The buyer knows its share count and ownership split, so it can model pro forma dilution on the day it signs.

Floating exchange ratio: the value holds, the share count moves

Under a floating exchange ratio, the agreement fixes the dollar value at $30 per TargetCo share, and the ratio resets off BuyCo's share price at or near closing, as the agreement defines it.

At $48, the ratio becomes $30 / $48 = 0.625x. BuyCo issues 6.25 million shares instead of 5 million, and TargetCo's holders end up with 6.25 / 51.25 = 12.2% of the combined company. They still receive $300 million of value.

Here BuyCo's shareholders carry the risk. A falling share price forces BuyCo to hand over a bigger slice of the company, and the extra dilution arrives when the stock is already weak. The target gives up its upside in exchange: at $72, the ratio drops to 0.417x and TargetCo's holders still get $30 per share.

How collars split the risk

A collar puts a band around the buyer's share price. One structure applies inside the band and the other takes over outside it. Take a band of $54 to $66, 10% either side of BuyCo's $60 signing price.

Fixed ratio with a collar. Between $54 and $66 the ratio stays at 0.50x, so each TargetCo share is worth between $27 and $33. Outside the band, the ratio floats to hold value at the edge. At $48, the ratio rises to $27 / $48 = 0.5625x, which guarantees TargetCo's holders a $27 floor. At $72, it falls to $33 / $72 = 0.458x and caps them at $33.

Floating ratio with a collar. Between $54 and $66 the value stays at $30, so the ratio moves between 0.455x ($30 / $66) and 0.556x ($30 / $54). Outside the band, the ratio locks at the nearest limit. At $48 it stops at 0.556x: TargetCo's holders receive about $26.67 per share, and BuyCo issues 5.56 million shares instead of the 6.25 million an uncapped float needs.

Some agreements add a walk-away right, letting the target terminate if the buyer's stock falls through a set threshold. The Wachtell memo calls these rare, so mention them as an add-on.

Put the four structures side by side and the $48 case looks like this:

Illustrative: BuyCo falls from $60 to $48 before closing, against a $30 offer and a $54 to $66 collar. In the collar rows, the first company's shareholders carry the fall down to $54 and the second's carry it below.

How it comes up in interviews

"Which structure would the buyer prefer?" A fixed ratio, because it knows how many shares it will issue and the resulting ownership split. The seller leans towards a floating ratio, because it knows the dollar value it will receive.

"The acquirer's stock drops 20% after signing a fixed-ratio deal. What happens?" The target's holders receive the same number of shares, worth 20% less, and the ownership split does not change. Candidates who mention the value drop and stop there miss half the answer.

"Why would a target accept a fixed ratio?" It keeps the upside if the buyer's stock rises, and its shareholders lock in a set stake in the combined company, so they share in whatever the merger creates.

"How does a floating ratio affect accretion and dilution?" If the buyer's price falls, it issues more shares, which raises the share count in the EPS denominator and makes the deal more dilutive. Linking two topics out loud shows reasoning over recall, the theme of Knowing the Answer Is Not the Same as Passing. For the model side, see how cash, debt and stock change a merger model.

The 30-second model answer

"The exchange ratio is the offer price per target share divided by the acquirer's share price. With a fixed ratio, the share count is locked, so the target's shareholders bear the risk of the acquirer's stock moving before close, and the acquirer knows its dilution. With a floating ratio, the dollar value is locked, so the acquirer's shareholders bear the risk: a falling share price means issuing more shares. A collar sets a price band and switches between the two at its edges, so one side carries the risk inside the band and the other carries it outside."

How to make it stick this week

1. Rebuild the BuyCo example on paper with a 30% drop instead of 20%. Work out value per share, shares issued and ownership under all four structures.
2. Say the 30-second answer aloud until you can do it without notes, then have a friend interrupt with "and who loses if the stock goes up?"
3. Read the terms of a real stock deal. In a US public stock deal, the buyer often registers the new shares on a Form S-4, which includes information about the transaction. Pull one up on SEC EDGAR, find the merger consideration, and identify which structure the deal uses.

For where signing fits in the wider deal, read the sell-side M&A process. More free material is in the Knowledge Base, and new pieces land in IBB Insights.