When we organize the initial public offering of a foreign company in the United States,
we usually need to make the foreign company become a wholly owned subsidiary of the U.S. corporation, or to merge the Foreign Company into the U.S. corporation.
Need or Necessity for a Swap
Whichever is the method, it is almost always required for the shareholders of the foreign company to exchange their shares of stock against shares of stock of the U.S. Corporation in order to make the Foreign Company a wholly owned subsidiary of the U.S. Corporation like that
The exchange of one quantity of shares of stock for another quantity of another of shares of stock. A stock swap occurs when shareholders’ ownership of the target company’s shares are exchanged for shares of the acquiring company as part of an acquisition or merger.
During a stock swap, each company’s shares must be accurately valued in order to determine a fair swap ratio.
By legal requirement of most jurisdictions, especially the U.S. federal one, at least 80% of the subsidiary (Foreign Company) must be owned by the mother corporation (U.S. Corporation) owned, so that the balance sheet of the subsidiary can be fully consolidated into the mother corporation.
If the Corporation owns even one single share of stock less than 80%, the balance sheet of the subsidiary can be consolidated into the mother corporation’s balance sheet, only pro rata of the percentage of ownership. In other words, if the Corporation owns 79% of the subsidiary, the balance sheet of the subsidiary can be consolidated into the into the mother corporation’s balance sheet at 79%.
Obviously this innocent legal requirement creates a situation in which the balance sheet of mother corporation owning 80% of a subsidiary to be overvalued by 20% of the subsidiary’s value !