Different types of Mergers and Acquisitions (M&A)
Mergers and acquisition can be categorized according to the nature of merger. Most mergers are simply done when one firm takeover another firm, but there are different strategic reasons behind this decision. In the same way, legal terminology also differs from merger to merger, hence it is important to differentiate and understand the subtle differences.
In this article we will look at 1) nature of M&A and different types of M&A, 2) reasons behind each type of M&A, and 3) legal terminology.
NATURE AND TYPES OF M&A
Mergers vs. Acquisitions
A merger takes place when two companies combine together as equals to form an entirely new company. Mergers are rare, since most often companies are acquired by other companies, and it is more of absorption of operation of the target company. The term merger is more often used to show deference to employees and former owners when another company is taken over. Mergers and acquisition are a means to a long-term business strategy. New alliances, mergers or takeovers are usually based on company vision and mission statements, and they have to truly reflect company corporate strategy in terms of what it wants to achieve with the strategic move in the industry. The process of acquisition or a merger calls for a disciplined approach by the decision makers at the company. Three important considerations should be taken into account:
- Company must be willing to take risk, and make investment early-on to benefit fully from the merger, competitors and the industry takes heed and start to merger or acquirer themselves.
- In order to reduce and diversify risk, multiple bets must be made, since some of the initiatives will fail, while some will prove fruitful.
- The management of the acquiring firm must learn to be resilient, patient and able to emulate change owing to ever-changing business dynamics in the industry.
Horizontal mergers happen when a company merges or takes over another company that offers the same or similar product lines and services to the final consumers, which means that it is in the same industry and at the same stage of production. Companies, in this case, are usually direct competitors. For example, if a company producing cell phones merges with another company in the industry that produces cell phones, this would be termed as horizontal merger. The benefit of this kind of merger is that it eliminates competition, which helps the company to increase its market share, revenues and profits. Moreover, it also offers economies of scale due to increase in size as average cost decline due to higher production volume. These kinds of merger also encourage cost efficiency, since redundant and wasteful activities are removed from the operations i.e. various administrative departments or departments suchs as advertising, purchasing and marketing.
A vertical merger is done with an aim to combine two companies that are in the same value chain of producing the same good and service, but the only difference is the stage of production at which they are operating. For example, if a clothing store takes over a textile factory, this would be termed as vertical merger, since the industry is same, i.e. clothing, but the stage of production is different: one firm is works in territory sector, while the other works in secondary sector. These kinds of merger are usually undertaken to secure supply of essential goods, and avoid disruption in supply, since in the case of our example, the clothing store would be rest assured that clothes will be provided by the textile factory. It is also done to restrict supply to competitors, hence a greater market share, revenues and profits. Vertical mergers also offer cost saving and a higher margin of profit, since manufacturer’s share is eliminated.
Concentric mergers take place between firms that serve the same customers in a particular industry, but they don’t offer the same products and services. Their products may be complements, product which go together, but technically not the same products. For example, if a company that produces DVDs mergers with a company that produces DVD players, this would be termed as concentric merger, since DVD players and DVDs are complements products, which are usually purchased together. These are usually undertaken to facilitate consumers, since it would be easier to sell these products together. Also, this would help the company diversify, hence higher profits. Selling one of the products will also encourage the sale of the other, hence more revenues for the company if it manages to increase the sale of one of its product. This would enable business to offer one-stop shopping, and therefore, convenience for consumers. The two companies in this case are associated in some way or the other. Usually they have the production process, business markets or the basic technology in common. It also includes extension of certain product lines. These kinds of mergers offer opportunities for businesses to venture into other areas of the industry reduce risk and provide access to resources and markets unavailable previously.
When two companies that operates in completely different industry, regardless of the stage of production, a merger between both companies is known as conglomerate merger. This is usually done to diversify into other industries, which helps reduce risks.
REASONS BEHIND EACH TYPE OF M&A
There are various reasons as to why a company might to decide to merge or acquire another company, although there has to be a strategic reasoning or logic behind the merger. All the successful mergers and acquisitions have a specific, well thought-out logic behind the strategic move. Mergers and acquisitions usually create value for the company in different ways, some of which are listed below:
Improve the company’s performance
This involves improving the performance of the target company, as well as the company itself. It is one of the most important reasons of value-creating strategies of M&A. If another company is taken over, its performance can be radically improves, due to economies of scale. Also, the two companies combined would have a greater impact in the market as they are more likely to capture a greater market share, hence higher revenue and profits. Operating-profit margins can be significantly improved under the new management if wastage and redundancies are removed from the operations.
Remove Excess capacity
In many cases, as industries grow, there comes a point of maturity, which leads to excess capacity in the industry. As more and more companies enter the industries, the supply continues to increase, which brings the prices considerably down. Higher production from existing companies and entry of new companies in the industry disrupts the balance as supply increases more than demand, which lead to a fall in price. In order to correct this, companies merge with or acquire other companies in the industry, hence getting rid of excess capacity in the industry. Factories and plants can be shutdown, since it is no longer profitable to sell at that low a prices. Usually least productive plants or factories are retired in order to bring the balance back to the industry. Reducing excess capacity has a lot of benefits as it extends less tangible forms of capacity in the industry. It makes companies rethink their strategy, and nudges them to work towards improving quality rather than quantity.
Mergers and acquisitions are often undertaken to increase the market share. If competitor company is taken over, its share of sales is also absorbed. As the result, the acquirer gets higher sales, revenues and consequently higher profits. Some industries have a mix of very loyal customers, which means that it is very difficult to attract customers from competition by other means, as the industry is highly competitive and consumers are disinclined to make the switch. In such circumstances, merger or acquisition are highly beneficial, since they provide an opportunity to drastically increase market share. It also allows economies of scale, as per unit cost decrease due to higher volume. Smaller players in the market are sometimes taken over to penetrate the market further, where big companies fail to make an impact. Controlling smaller firms in the industry can greatly accelerate sales of those smaller companies’ products and services, since a big name is now attached to them. The acquirer also brings in its expertise and experience to bring efficiency to the operations of the target company. The combined company also benefit from exposure to various segments of the industry, which were previously unknown to the acquirer. The new combined company could help introduce new products tailored for the unchartered markets, hence finding new consumers for the same products and services.
Acquire skills and technology
Companies often acquire or merge with other companies in hopes to acquire skills and/or technology of the target company. Some companies control certain technologies exclusively, and it is too costly to develop these technologies from scratch. This means that it is easier to take over a company with the desired technology. A merger / an acquisition provides an opportunity for both companies to combine their technological progress and generate greater value from the sharing of knowledge and technology. These kinds of merger usually lead to innovation and entirely new products and services, hence are beneficial not only to the companies themselves, but to the industry as well. Same goes for skills, which are in certain cases exclusive, and can only be sought out, if the said company is taken over.
Some firms are too small in the market and are highly fragmented, which means they experience higher costs, and it is not feasible for them to keep up operations because there are no economies of scale due to a very small volume. An acquisition is such case is more common and can be hugely beneficial to the target company, as it could keep on operating only with an element of economies of scale. It would also help an acquirer, since it would be able to penetrate smaller fractions of the market, as smaller companies have access to these markets. Hence this kind of merger creates value for both companies, and promises greater efficiency in the operational activities. Advertising campaigns can be coordinated together in order to increase revenues and save on costs.
Encourage competitive behavior
Many companies decide to take over other companies in an attempt to improve the overall competitive behavior in the industry. This is done by eliminating price competition, which leads to improvement in rate of internet return of the industry. If the competition is kept at bay, and new entrants are not allowed, firms don’t have to compromise on quality as price is no longer a competing factor. Smaller businesses can only gain share through offering at lower prices, but price competition reduces overall profits for the industry. In order to restore the balance, and invest all effort an energy on quantity, mergers and takeovers are initiated to improve the overall competitive environment in the industry.
Mergers and acquisitions are highly complex, and they most often require authorization from central government organization like competition commissions. There are various legal terminologies used when companies decide to merge as listed below:
Sale of Majority of Assets
In a merger / acquisition of one by another company, one company buys out the majority of assets of the other company. The control is transferred to the acquirer after approval of majority of shareholders of the target company. The acquirer usually only takeover liabilities that are attached to the purchased assets, which means that other liabilities are retained by the target company and paid off by them through their own means. Acquirer may, at times, decides to take up liabilities too. Shareholders have the same rights after the merger, since they are entitles to a divided, which is usually higher after the merger.
Stock for Assets
In this type of transaction, one entity buys outs the other one for a certain number of shares. The target company dissolves, passing all its assets to the acquirer. The control is established after approval from acquirer Company’s management. For the target company, vote of approval from majority shareholders is required for the dissolution. All the liabilities attached to the assets of Target Company are passed on to the acquirer company, while all other liabilities are retained by the target company unless acquirer volunteers to take them on as well. Shareholders after the merger are likely to receive a higher dividend.
Stock for Stock
Stock for stock transaction involves two companies, where one entity buys shares in another company from its shareholders. The target’s company’s assets are passed on to the acquirer, while the target company is run as a subsidiary of the acquirer. A new stock has to be created for this kind of merger, which means that the majority of the acquirer company’s shareholders are required to approval the merger. The shareholders of the target company are able to individually decide whether they want to participate or not. The merger entails limited liabilities for the acquirer in terms of target’s company liabilities. If shareholders decide not to sell their shares, they might be frozen out.
This kind of transaction requires the presence of two companies. One company purchased the other, or alternatively both dissolve and become a new company. In this case, both companies require approval from majority of shareholders. The company or the acquirer takes up all rights and all liabilities, some of which are unknown to both corporations. Shareholders retain the right to receive dividends, in addition to retaining dissenter’s appraisal rights. This is the most common sort of merger, which basically means that one company is absorbed into the other one. Assets are taken over, while liabilities are cleared at the time of the merger or takeover the acquirer.
Dissolution involves only one corporation, since the company is being dissolved. If the company wants to dissolve voluntarily, it needs the majority vote by shareholders in addition to filing with the state. At times, courts order involuntary dissolution in certain cases such as a deadlock situation. The control is usually held by majority vote by shareholders. In the case of dissolution, all liabilities must be cleared, although any future liability is absolved. Dissolution usually means that the company does not exist anymore, which means its operations are wrapped up during the process dissolution.
In this case, the majority shareholders attempt to buyout the shares of the minority of shareholder. Only one company is involved, and control is defined by the majority through board approval. The liabilities in this case remain with the company as there is no other party involved. This is mostly done to reaffirm control by the majority shareholders over the operations of the company, since they face no obstacles once the deal goes through.
This merger is similar to stock for stock, the only difference being the shareholders are offered money in exchange for their shares, after which the target company is dissolved, merged or run as a subsidiary. Management approval is needed since the acquirer usually borrows to finance the merger. While individual shareholders of Target Company may sell at their will, although a controlling percentage of target company’s shared is required for this mergers. After the purchase of shares, the acquirer has limited liability in terms of target’s company financial obligations. After the merger, shareholders can expect a higher dividend, while shareholders of target have no right, since they are no hold shares.
As the name suggest, this merger involves three companies. The first step involves the acquirer company forming a subsidiary, whose only assets are shares of the parent company. The newly formed subsidiary then does a stock for assets or stock for stock as explained above with the target company. Consequently, the target company mergers or completely dissolves.
In Palo Alto (CA), we talked with venture capitalist Andrew Ogawa from Quest Venture Partners …