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What are Contingent Shares?

  •  5 min read
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  • 01 Nov 2023
What are Contingent Shares?

Key Highlights

  • Contingent shares are special stocks issued under specific conditions.

  • They are typically issued when a company makes a profit, meets earnings expectations, or during a merger and acquisition (M&A) process.

  • The number of contingent stocks issued affects the company's earnings per share (EPS) and can lead to a dilution of existing shareholders' ownership.

Contingent shares definition refers to the stock that is issued to a shareholder under special circumstances. As with regular common stock, they are issued when a company makes a profit, meets earnings expectations or during a merger and acquisition (M&A). By issuing contingent shares, existing shareholders' ownership becomes diluted.

After understanding contingent shares meaning, let's explore how they work. So, assume Company R is acquiring Company G. The two companies are unable to agree on certain terms during this process. In spite of negotiation, they have not been able to resolve these issues. Company R and Company G reach an "if-then" agreement by issuing contingent stocks.

Company R can set an earnings target for Company G, and if these targets are met, Company R will issue a certain number of common shares to the shareholders of Company G. As an example if Company G increases its earnings by 15% in the current fiscal year, then Company R will issue 4,000 common shares to its shareholders.

So, in what ways does this benefit Company G's shareholders? In theory, the increase in earnings is offset by the increase in shares. In this case, contingent shares are structured in such a way that shareholders ultimately profit. Consider Company G's current earnings of Rs. 2,00,000. The company has issued 50,000 common shares so far.

Current Earning per Share = (Total Earning/Common Shares) = (2,00,000/50,000) = Rs. 4

Company G will issue 4,000 common shares if it is able to increase earnings by 15%. New Earning = (Rs. 2,00,000 * 115%) = Rs. 2,30,000 Number of shares = 50,000 + 4,000 = 54,000 New Earnings Per Share = (Rs. 2,30,000/54,000) = Rs. 4.25 When the contingencies are met, and new shares are issued, Company G's shareholders earn more per share.

Contingent shares play a huge role in mergers and acquisitions. When the party isn't sure about the company's profitability, contingent stocks serve as a safety net, and the deal's more likely to go through. Current shareholders are encouraged to be more involved and keep the company in check since they directly get benefited when the company does well.

Companies often use contingent shares in high-growth industries because buyers are skeptical about profitability and future performance, while sellers are confident and optimistic. This is why contingent stocks are useful in acquisitions, as they balance the two perspectives and can be used successfully. To prepare and raise funds for a variety of contingencies, companies issue conditional stock. In addition to offering financial protection, it is also an attractive way to earn incentives.

The issuance of contingent shares can benefit many stakeholders, and it is a strategy that ensures satisfaction for all parties. Contingent stocks are offered to new shareholders as a bonus to increase their investment appeal. These shares provide additional incentives for managers to improve the firm's performance. As a result, it motivates them to ensure that contingencies are met.

In the acquisition phase, this is one of the most important processes, creating a situation that benefits both the acquirer and the target. If the acquired company is offered conditional consideration, it may be motivated to continue working with them after the acquisition because of the potential for additional profits.

Conclusion

Contingent shares are like special stocks given out under specific conditions, mainly during mergers and acquisitions. They have a big role in making sure that both the company buying and the one being bought benefit from the deal. These shares encourage shareholders to work hard to meet the conditions set, and this hard work can mean more earnings for the shareholders. When there is uncertainty about profitability, contingent shares act as a safety net.

FAQs on Contingent Shares

Contingency shares are different from ordinary shares. Basically, they are common shares that are issued when certain conditions are met. For example, if Company A acquires Company B, Company A will issue contingent shares if Company B achieves certain earnings targets.

Contingent value rights are rights that are tied to a future event. The rights holder receives the benefit, such as a cash payout, if the condition is met. The right becomes worthless if it's not.

A contingent consideration should be recorded at the time of acquisition. Depending on their fair value, they will be listed as liabilities or equity. Most of the time, you will recognise the consideration as a liability. The consideration would qualify as equity if a fixed number of shares were involved.

The contingent shares are included only in fully diluted EPS because the earnings requirement has not been met.

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