Definition
Contingent shares are shares of a company that are issued only if certain specific conditions are met. These conditions, also known as performance goals, may be related to the company’s financial performance, a merger or acquisition, or any other predetermined measure of success. Contingent shares can act as incentives for company management to achieve set targets.
Key Takeaways
- Contingent shares are shares issued by a corporation that are subject to achieving certain predetermined objectives. This can include hitting specific financial targets or completion of a particular project.
- They are often used as an incentive for management or employees, as they only become beneficial once the set targets are met, aligning the interests of the staff and shareholders.
- Contingent shares can carry voting rights, or they may not, depending on the specific terms of the issue. Also, they may be converted to ordinary shares or be paid out in the form of dividends once the set targets have been reached.
Importance
Contingent shares are a significant aspect of financial agreements as they allow flexibility and potential for higher profits in business transactions.
They are essentially additional shares that an acquirer may have to issue to the target firm’s shareholders, contingent upon specified future events or metrics, such as earnings targets.
This strategy can be beneficial in acquisitions and merger situations, serving as a form of risk management.
It helps in aligning the interests of the existing and new shareholders, and may also provide a form of reassurance or incentive for the target company.
The use of contingent shares can influence the valuation of the deal and the negotiation process, making it a crucial term in the realm of finance.
Explanation
Contingent shares serve as an effective tool for companies to manage corporate finance, align employee incentives with company performance, and structure strategic agreements. These shares are connected to specific predefined conditions or triggers, such as performance milestones, financial ratios, or even external events, and they become applicable when these conditions are met. Companies often use contingent shares in remuneration packages for executives or other high-level employees.
Setting performance goals, for instance, revenue targets or profit margins, motivates employees to strive for excellence. It’s an effective way of aligning employee performance with the company’s overall objective. Moreover, contingent shares play a critical role in corporate actions like mergers and acquisitions.
Parties in a merger or acquisition agreement often use contingent value rights, essentially contractual promises for additional shares, to help bridge a valuation gap between companies. If, following the merger or acquisition, the combined entity’s stock price falls short of a predetermined level, the contingent shares are issued, providing a hedge for the investors against the risk of a declining stock price. Thus, contingent shares are used for more effective and informed decision-making in business strategies.
Examples of Contingent Shares
Company Acquisitions: One of the most common examples of contingent shares can be found in company acquisitions. For instance, when Facebook acquired Instagram, part of the payment to Instagram consisted of Facebook shares. These shares were contingent on certain future events or milestones, such as customer growth or revenue targets. If Instagram failed to meet these goals, the number of shares it received would be decreased.
Employee Compensation: Another example involves employee compensation packages. Many companies, especially startups, offer their key employees stock options or shares as part of their compensation. These shares are often contingent upon the employee meeting certain performance goals or remaining with the company for a certain period of time. If the employee fails to meet these conditions, they may not receive the full amount of shares promised.
Convertible Bonds: Convertible bonds are a type of debt security that can be converted into a predetermined number of the company’s shares. The conversion may be contingent on the company’s stock price reaching a certain level. If that condition is not met, the bondholders continue to hold the bonds and receive interest payments instead of converting them to shares.
Frequently Asked Questions About Contingent Shares
What are Contingent Shares?
Contingent shares are shares issued by a corporation that are subject to certain conditions being met. These conditions can vary largely, ranging from sales targets for the company to specific performance goals for an executive.
What happens if the conditions are not met?
If the conditions are not met, the contingent shares may not be issued. Alternatively, they could be issued at a later date if the conditions are met. This all depends on the specific terms and conditions outlined in the contingent shares agreement.
Are contingent shares common in Mergers and Acquisitions?
Yes, contingent shares are often used in Mergers and Acquisitions (M&A) transactions. They allow the buyer to pay the seller with the buyer’s own shares, only if certain conditions are met after the M&A transaction is completed.
What is a Contingent Value Right (CVR)?
A Contingent Value Right (CVR) is similar to a contingent share, but instead of shares, the holder receives monetary compensation if the predetermined conditions are met. CVRs are typically used in M&A transactions when the two parties can’t agree on the value of the company being purchased.
Are Contingent Shares the same as Restricted Stocks?
No, Contingent Shares and Restricted Stocks are not the same. Restricted Stocks are shares that are given or sold to an employee, but they cannot be sold until certain conditions are met, usually a specific amount of time. On the other hand, Contingent Shares may never exist if the predetermined conditions are not met.
Related Entrepreneurship Terms
- Escrow Shares
- Vesting Schedule
- Earn-Out Agreement
- Equity Compensation
- Convertible Securities
Sources for More Information
- Investopedia: A comprehensive source for understanding and applying financial concepts. It offers dictionary-like definitions along with in-depth features, videos and tutorials.
- Nasdaq: Known for its stock exchange, Nasdaq also provides wide resources on financial terms including contingent shares. It presents the latest news and expert analysis on various financial topics.
- Corporate Finance Institute: Provides online financial training and certification programs. It is a great source for understanding the nitty-gritty aspects of finance related terms.
- The Balance: Offers expert insights on a wide array of topics related to financial planning, investing, and money management.
