Mergers and Acquisitions - Explained
What are Mergers & Acquisitions?
If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.
- Marketing, Advertising, Sales & PR
- Accounting, Taxation, and Reporting
- Professionalism & Career Development
Law, Transactions, & Risk Management
Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
- Business Management & Operations
- Economics, Finance, & Analytics
Table of ContentsWhat are Mergers and Acquisitions?How do Mergers & Acquisitions Work? What Is the Difference Between a Merger and an Acquisition?Varieties of MergersDetails of AcquisitionsValuation MattersThe Premium for Potential SuccessWhat to Look for in Mergers and AcquisitionsWhy Merge?Mergers and Acquisitions-Prone IndustriesDoing The DealWhat Merger And Acquisition Firms DoInvestment BanksLaw FirmsAudit & Accounting FirmsConsulting & Advisory FirmsM&A Effects Capital Structure and Financial PositionM&A Effects Market Reaction and Future GrowthM&A Effects The WorkforceThe Impact of Foreign ExchangeWhy Mergers Don't Go ThroughHostile TakeoversDefensive ManeuversAcademic Research on Mergers and Acquisitions - M&A
What are Mergers and Acquisitions?
Mergers and acquisitions (M&A) is described as an amalgamation of two or more companies. When the ownership of companies are integrated, consolidated or transfers, mergers and acquisitions has occurred. When two companies or businesses combine their business operations and begin to function as one entity, merger has occurred. Acquisition however occurs when a company takes over a smaller company and the acquired company functions as a subordinate of the acquiring company. Mergers and acquisitions (M&A) is also used in financial accounting to describe the consolidation or aggregation of the financial statements of the merged or acquired companies and the finance department that facilitates M&A.
How do Mergers & Acquisitions Work?
There are certain terms that are essential in a mergers and acquisitions, they explain the activities that occur for the consolidation of companies to occur. These are:
- Purchase of assets: When an acquiring company buys the assets of a target company, this is acquisition of assets. The purchase can be made after the target or acquired company receives shareholders' approval.
- Mergers: A merger occurs when two companies combine their activities, holdings and assets to have a single identity. While in some mergers, the two companies take up another business name, in most mergers, one company (usually the weaker) loses its identity and take up the name of the other company.
- Acquisitions: When a stronger company takes up the ownership of a weaker company, acquisition has occurred. It is a process in which the acquiring company acquires the majority shares of a target company.
- Consolidations: For a consolidation to occur, the shareholders of the two companies must give approval. The aim of consolidation is to birth a new firm or company.
- Management acquisitions: This is an acquisition in which the top executives of an acquiring buy the highest stake of the acquired company, thereby privatizing it.
- Tender offers: An activity in which an acquiring company offers to the shares of another company at a specific price is called a tender offer. This agreement or business deal is reached with the shareholders of the target company rather than the board of directors or management of the company. When shareholders sell their holdings of a company in a tender offer, a dilution of a company's shares has occurred.
What Is the Difference Between a Merger and an Acquisition?
Despite that mergers and acquisitions are often used interchangeably, both concepts have different meanings. Also, most acquiring companies regard acquisitions ss mergers, even though it is not, just to save the name of the acquired company. The major differences between mergers and acquisitions are;
- In a merger, two companies, often of equal size and strength combine their resources, assets, manpower and operations, so as to function as one entity. Often, when two companies are merged, a new entity is created.
- Acquisition, on the other hand, occurs when a stronger company purchases another company. No new entity is created in an acquisition, rather, the acquired company is submerged and becomes a part or subsidiary of the acquiring company.
- In most cases, mergers are regarded friendly while acquisitions are regarded as hostile takeovers. Acquisitions are also seen in a derogatory perspective by the acquired companies. Also, companies that are taken over through acquisitions are seen in a bad light by the public.
Varieties of Mergers
There are different types of Mergers, this is dependent on the relationship that exist between the two consolidated companies. The common types of Mergers are:
- Conglomeration: This refers to a merger between two businesses that operation in distinct industries. The businesses have no business relation or nothing in common but are merged to form a conglomerate.
- Consolidation mergers: This is two companies coming together to form one new entity. Both of them relinquish their old identities and are formed as a new entity.
- Purchase mergers: In this type of merger, one company purchases another company whether through cash or other financial instruments.
- Vertical merger: A merger between a supplier and a company or a customer and a business.
- Horizontal merger: This is a merger between two companies that manufacture the same products and have the same range of customers.
- Congeneric merger: This occurs when two different companies that offer distinct services to the same customers merge. For instance, a mobile network service and a service provider.
Details of Acquisitions
Oftentimes, when we talk of acquisition, the conclusion that people make is that a stronger company has paid a huge sum of money to acquire another company. While it is possible for a company to purchase another company with cash, there are other ways through which acquisition can occur. The acquiring company can offer stock to purchase a target company or acquire all of its assets. A reverse merger is a form of acquisition whereby a strong private company acquires a publicly listed company, and becomes a publicly-listed company through reverse merging.
The worth of a target company is a critical factor that must be considered in mergers and acquisitions (M&A). The seller in an acquisition is the management or board of directors of the target company. There are many disputes when it comes to the valuation of a company because the seller will want to sell the company at a high price, while the buyer will price it at the lowest price possible. To avoid disputes that emanate from the valuation of a company, there are some valuation methods that can be applied when assessing the value of a target company. The most used valuation methods are;
- Comparative ratios.
- Enterprise-value-to-day ratio (EV/Sales).
- Price-earnings ratio (P/E ratio)
- Replacement cost.
The Premium for Potential Success
In every acquisition, sellers sell their companies when they know they would benefit more from the amalgamation, no seller sells at a loss. One of the determinants of selling a company is that guarantee that the buyer would pay a premium when the company is acquired. Payment of Premium on the stock of an acquired company is an important component in every acquisition. The acquiring company pays a premium to create a synergy since shareholders benefit more when the post-merger share price of a company rises as a result of premium. For a post-merger synergy to be achieved after acquisition, buyers must commit to pay the premium. Premium is also used in measuring the success and synergy achieved through a merger.
What to Look for in Mergers and Acquisitions
There are some qualities, factors or benefits that investors look out for in mergers and Acquisitions. The major factors they look for are;
- The likelihood of success of the merger and acquisition.
- The purchase price, whether the price offered is reasonable and worth the value of the acquired company.
- A synergy or connection between the acquiring company and the acquired company.
- If the acquisition is done by cash payment or stock or other forms of payment. This is because the valuation tend to be different.
When mergers and acquisitions occur between firms, there is always a common question people ask, which is "why merge?" Mergers and acquisitions take place for several reasons but top on the list is to create synergy between the companies involved. Synergy takes place in different forms, including synergy in the value, worth, relevance and productivity of the companies. Other reasons companies merge include to grow bigger in size and have a higher economic value. Companies also engage in mergers and acquisitions to become dominant and powerful in the industry, this will foster competition with other brands and also make them stay ahead of the competition. Aside from the reasons listed above, there are other benefits attached to mergers and acquisitions which is why many companies engage in them. The most significant benefits are tax benefits, cost reduction, employee-size reduction, higher sales and profits, improved purchasing power as the company has higher leverage in purchasing equipment, raw materials and inventory.
Mergers and Acquisitions-Prone Industries
There are some sectors and industries that are prone to mergers and acquisitions due to certain reasons. These sectors include the financial services, utilities, health care, technology sector, and others. The major reason why these sectors are prone to mergers and acquisitions is that things rapidly improve and change in these sectors. For companies in these sectors to remain relevant, they need to keep improving and this requires a lot of money. For instance, health and technology companies need massive funding in order to keep themselves updated and purchase modern equipment. Due to this demand, small and medium sized companies may find it difficult to survive without going through mergers and acquisitions. If these categories of companies attempt to compete with others, they might be swept under, hence, mergers and acquisitions remain a means of survival. For companies in the financial sector, financial crisis and economic downturn remain a reason for mergers and acquisitions. Economic conditions also affect the retail and utilities sectors which makes mergers and acquisitions impossible to bypass.
Doing The Deal
The core processes involved in every merger and acquisition are:
- The opening offer: This entails the acquiring company making a decision regarding whether they want to go through with a merger and acquisition or otherwise. The decision is made by the company's board or top executives. An opening offer must start with a tender offer which entails executives of the acquiring company speaking directly with the shareholders of the target company, bypassing the management. In a tender offer, the acquiring company starts to purchase the shares of the target company discreetly. In an opening offer, the acquiring company must carry investment banks and financial advisors along. A letter of intent (LOI) must be presented to a target company for the intended merger and acquisition.
- The response of the target company: When an acquiring company gives an LOI to the target, it contains an overview of the proposed transaction, the offer price, and other terms. The target company can either accept or reject the offer. The top executives and shareholders of the target company will decide whether to accept an offer for merger and acquisition or otherwise. In some cases, negotiations can occur between the target and acquiring company, this is often done when there is a need to undergo a merger and acquisition but the terms or offer are not favorable. The negotiation will also determine whether the target company needs to foil the takeover or look for another acquiring company.
- The closing deal: This is when the transaction or merger will be executed after the target company had accepted the offer and all requirements by the governing council are met. The acquirer can purchase the target company either by cash or stock. Upon closing of the deal, investors and shareholders of the target company receive new stock in their investment portfolios and identify with the new entity.
In every merger and acquisition, the regulatory body must be involved, this body scrutinizes and approve of the deal.
What Merger And Acquisition Firms Do
Firms or organizations in charge of Mergers and acquisitions help the acquiring and target companies to facilitate the transaction. These firms take responsibility for the consolidation or amalgamation process in exchange for a fee paid by the acquiring or target company depending on which hired the firm. Also, the roles and duties different merger and acquisition firms play vary. Mergers and acquisitions firms and their roles are highlighted below.
In a merger and acquisition, an investment bank performs 0p role of an intermediary between the acquiring company and the target company. They also act as financial advisors to the company that hired them, they negotiate on behalf of the company from the opening to the closing of the deal. An investment bank facilitates a merger and acquisition and ensures that that transaction follow due processes. For acquirers, investment banks compile a list of target companies and carries out proper assessment of all the companies for the purpose of the merger and acquisition. They also do a valuation of the target company to determine its value and how much should be offered.
In a merger and acquisition, a law firm performs legal duties and resolve all legal issues resulting from the transaction. Most importantly, law firms give legal advice to the acquiring of target company and ensures that no legal issue emanates from the deal. Companies looking to merge with or acquire other companies engage the service of corporate law firms. Mergers and acquisitions are serious transactions that should be handled by law firms with expertise and success records on such transactions.
Audit & Accounting Firms
An audit and accounting firm is another firm that plays an essential role in mergers and acquisitions. Such firm specializes in handling all accounting matters and aspects relating to taxation and auditing. An audit and accounting firm also render advisory services on accounting and taxation to companies undergoing mergers and acquisitions.
Consulting & Advisory Firms
Consulting and advisory firms guide companies and prevent them from going into errors during mergers and acquisitions. These firms are sensitive to the nature of type of Mergers and acquisitions, in order to efficiently guide their clients. A consulting and advisory firm can also help big companies look for good targets and companies suitable for the merger or takeover. The firms also give advice on prices, company valuation and assessment, among others.
M&A Effects Capital Structure and Financial Position
A merger and acquisition has effects on the structure of both the acquiring and target companies. Although, target companies experience short-term change in the capital and financial structure, that of the acquirer is long-lasting. The size of the mergers and acquisitions determine the effects of impacts that the acquirer and the target face. Usually, when the target has a big size, the acquirer face higher risks because if the target company is a failing one, the acquirer might experience failure of the transaction due to inability to absorb the lapses of the target. Typically, a M&A transaction has high impacts on acquirer. The most significant impact is a change in the capital structure of the acquirer since it had expend its capital in the purchase of the target. Oftentimes, most acquirers do not have sufficient cash to make the purchase and they end up using debt financing.
M&A Effects Market Reaction and Future Growth
In every merger and acquisition, the future growth of the acquirer is at stake, the acquisition can either affect future growth positively or adversely. In some past M&As, the acquirer had experienced a high level of success and future growth while in others, the acquirer deteriorates and eventually crashes. While the stock of the target company rises even above the acquirers stock and offer price, the acquirers shares may decline due to a number of reasons. For instance, if investors or shareholders detect that the acquiring company has taken in huge debt to finance the merger and acquisition, the shares are likely going to drop. Ultimately, the future growth and success of an acquirer is affected by an M&A, this can be positively or negatively, depending on the nature and size of the M&A. if after a merger and acquisition has taken place, the core business and profit of the acquirer is deteriorating, it is a sign that the effects are more negative than positive.
M&A Effects The Workforce
Mergers and acquisitions have an effect on the workforce of both the acquired and the acquirer and this can be in a positive or negative way, especially for employees of target companies. Since the management of the target companies no longer decide who will be in the workforce, acquirers often retain employees with most values while others are dismissed. Most employees lose their jobs after an M&A, this is because many departments are merged or collapsed into one while some departments become irrelevant and the employees laid off. Oftentimes, the category of employees affected my M&As are top executives, senior officers and CEOs of the target companies, on few occasions, the general employees work can also be threatened.
The Impact of Foreign Exchange
Cross-border M&A transactions refer to mergers and acquisitions that occur between companies in different countries. In such M&As, foreign exchange has an effect on the transaction since the transaction borders on the value of the currency of the countries involved. To avoid negative impacts of foreign exchange on M&A transactions, acquiring companies often target companies in countries whose currencies are not as strong as their currencies, that is, companies in countries with weak currencies remain the target. Oftentimes, cross-border M&A transactions require huge capital, this is why acquirers choose targets in weak currencies in order to hedge the impact of foreign exchange. Hence, it is essential to structure M&As to hedge or accomodate the impacts of exchange rates on the currencies involved. Also, the size of the transaction determined the level of impacts that will be felt on currency exchange rates.
Why Mergers Don't Go Through
Not all mergers and acquisitions are successful, in fact, on many occasions, M&As go not happen, even if they were planned for. The major reasons mergers and acquisitions fail are;
- Insufficient funding or lack of capital.
- Dispute on the valuation of the target company between the acquirer and the target.
- Government regulations or restrictions.
Funding is crucial to every M&A, a deal that sets off with an inadequate funding is set to fail. In some cases where there is adequate funding, government regulation has made some M&A transactions not to go through. Also, it is important to know that many mergers and acquisitions deals are not successful at the first trial, some encounter failure at certain stages because the last successful deal is achieved.
Acquisitions are commonly regarded as hostile takeovers because of the manner in which acquiring companies approach or target the target companies. Acquirers use several strategies in a hostile takeover, the common ones are Saturday Night Special and Dawn Raid. In a Dawn Raid, investors or an acquiring firm begins to purchase a significant portion of the targets equity in the stock market, this is done using third parties such as brokers. Once the acquiring firm accumulates a substantial part of the targets equity, the acquire has a controlling stake in the target company and by the time the target is aware of this, redemption is too late. In a Saturday Night Special, on the other hand, an acquirer makes an abrupt tender offer to the target without any preemptive notice. This is a sudden approach of taking over a target company, because it is done during the weekends, the name, Saturday Night Special emerged.
When a target company detects a hostile over, there is always a defense mechanism put up to foil the takeover bid. There are many defense strategies that target companies, the commonly used ones include the following;
- Greenmail: This is a technique used by a target company to frustrate the attempt of an acquirer to takeover the company. It entails an unfriendly company purchasing a large block of stock of the target company which the company buys back to foil the takeover bid. When repurchases, the stock is bought back at a premium, this defense is often called a blackmail or a bon voyage.
- People pill: This is a threat by the employees and the management team to resign their jobs if the target company is taken over. Losing all employees, including the important ones may be dangerous for an acquirer. However, this strategy does not always work because some acquireers would dismiss the employees in the first place.
- Golden parachute: This mechanism entails offering huge employee-benefits to employees and top executives who lose their jobs in atakeor, this means the acquire must pay the employees the agreed moment once the takeover is done. The benefits are huge sum on money, almost impossible for an acquirer to pay, thereby discouraging the takeover.
Other defensive maneuvers that are commonly used are sandbag, poison pill, white knight, macaroni pill/defense, and others.
Academic Research on Mergers and Acquisitions - M&A