Mergers and Acquisitions are part of strategic management of any business. It involves consolidation of two businesses with an aim to increase market share, profits and influence in the industry. Mergers and Acquisitions are complex processes which require preparing, analysis and deliberation. There are a lot of parties who might be affected by a merger or an acquisition, like government agencies, workers and managers. Before a deal is finalized all party needs to be taken into consideration, and their concerns should be addressed, so that any possible hurdles can be avoided.

Mergers and Acquisitions: A Complete Guide

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In this article, we look at 1) an introduction to M&A, 2) motives for M&A, 3) transaction characteristics, and 4) regulations and other hurdles.

INTRODUCTION TO MERGERS & ACQUISITIONS

‘Mergers and Acquisitions’ is a technical term used to define the consolidation of companies. When two companies are combined to form a single unit, it is known as merger, while an acquisition refers to the purchase of company by another one, which means that no new company is formed, but one company has been absorbed into another. Mergers and Acquisitions are important component of strategic management, which comes under corporate finance. The subject deals with buying, selling, dividing and combining various companies. It is a type of restructuring, with the aim to grow rapidly, increase profitability and capture a greater proportion of a market share.

Parties in an acquisition:

  • The Target Company is the company that is being acquired.
  • The Acquirer company is the company that is acquiring the target.

Mergers can be divided into three types:

  1. Horizontal merger: It happens when both companies are in the same line of business, which means they are usually competitors. Example: Disney bought LucasFilm. Both companies were involved in production of film, TV shows.
  2. Vertical merger: This happens when two companies are in the same line of production, but stage of production is different. Example: Microsoft bought Nokia to support its software and provide hardware necessary for the smartphone.
  3. Conglomerate merger: This happens when the two companies are in totally different line of business. Example, Berkshire Hathaway acquired Lubrizol. This kind of merger mostly takes place in order to diversify and spread the risks, in case the current business stops yielding adequate profits.

Introduction to M&A

The main difference between a merger and an acquisition is that a merger is a form of legal consolidation of two companies, which are formed into a single entity, while an acquisition happens when one company is absorbed by another company, which means that the company that is purchasing the other company continues to exist. In the recent years, the distinction between the two has become more and more blurred, as companies have started doing joint ventures. Sometimes acquirer wants to keep the name of the acquired company, as it has goodwill value attached to it.

M&A consolidationMergers and acquisitions are complex area of a company long-term strategy. The process takes a long time, at times, even years. It involves number of parties and stakeholders:

  1. The two companies which are being merged or coordinating to venture are the main stakeholders, since any changes in the structure of the company is likely impact both companies.
  2. Employees will also be affected, since they are an integral part of the companies. At times, during a merger or acquisition employees have to be laid off.
  3. The government agencies play a decisive role in any merger or acquisition, as they want to make sure that the M&A does not create a monopoly or impinge on the rights of general public. Any merger of acquisition must not be a hurdle to competitive environment in the industry.
  4. Pressure Groups would be interested in the impact the merger or acquisition would have on the environment, worker welfare, consumer welfare and overall social impact the collusion. Some companies manufacture product/services that are controversial, hence detested by some people. Firms must find a way to deal with possible hostility from these people.
  5. Competitors would be interested in a possible merger or acquisition between two companies in the industry, since a collusion could threaten to take away their market share as the combined company would be more powerful, financially and strategically.
  6. Financial institutions also have a stake in possible merger or acquisition, since the companies involved might have outstanding debt. Alternatively, a company involved in a post-merger or an acquisition might want to borrow more money, so that the financial institutions would have to evaluate the company’s financial standing and ability to repay it later.

M&A example - mergerThe Mergers and Acquisitions Process

MOTIVES FOR MERGERS AND ACQUISITIONS

Synergy

From the strategic point of view the main motive behind a merger or acquisition is to improve the company’s performance for its shareholders through synergy, which is a concept that states that the value and performance of two companies combined will be greater than the sum of the separate individual parts. Two businesses can combine to form one company which can generate more revenues that could be done if they worked independently. This is why potential synergy from merger and acquisition is evaluated before the decision is made.

Growth

Mergers or acquisitions can exponentially increase the growth of the company, as it has more resources at its disposal. When two companies combine their expertise, assets and market share are also combined, which leads to more opportunity in the market for growth. The market share which was previously shared by two companies will now exclusively belong to one company. The increased market power is likely to generate more opportunities for sales, revenue, and profitability.

Acquiring Unique Capabilities

Sometimes, mergers and acquisitions take place in order to acquire unique capabilities or resources, which could prove paradigm-shifting for the company. This would include patents and licenses, which the acquiring company will gain access to once the merger is completed. A patent, license or certain technology could make a lot difference for the company, which could help it substantially increase sales and profits, since it might create a natural monopoly situation for the new company. When two different companies combine, it could also result in unlocking hidden value, which becomes apparent as resources and experiences combined bring innovation and efficiency.

Exploiting the Market

Market systems in most economies are not perfect, which means there is room for companies to exploit these imperfections to their own advantage. Taking over another company or merger could facilitate a monopoly-like situation, which would give the company an edge over its competitors. Alternately, a merger could be done with a motive to control the supply of certain raw materials which will give the company an undue advantage over other companies.

As an Answer to Government Policies

Mergers and acquisitions also take place in order to cope with adverse government policies, which may require a certain size of a firm to exist. Some governments offer tax breaks and other incentives to large corporations, which encourage mergers as more profit can be made as tax liability is lower. In order to deal with government pressure to survival within an industry, companies mergers and acquisitions have greater leverage to influence government policies.

Transfer of Technology

Another popular reason for mergers and acquisitions is transfer of technology, especially for highly specialized companies with unique technologies. Companies buy other companies in an attempt to acquire a certain technology which is patented or unique. Subsequently, these technologies are used to make better products/services, hence greater market share and profits.

To Handle Large Clients

Mergers and acquisitions, especially in the service industry, also take place in order to follow big clients. There are a lot of examples of such M&A activity happening for law firms, since sometimes the clients are so big, it forces firms to merge in order to serve them better. The merged firms have more resources and expertise to handle powerful clients. It also gives companies a way to bootstrap earning, hence better performance at the stock exchange for listed companies.

Diversification

Mergers and acquisitions allow companies to diversify into other areas of business, hence it spreads risks and present opportunity for more sales, profits and recognition in the market. For example, if clothing store merges with a textile company, it would help both companies, since they would be able to keep a greater margin of profit. Diversification can also take place in a totally different industry altogether. For example, if a restaurant chain store acquires a clothing store, it would have reduced its risks, since even if people stop eating out, hypothetically speaking, they could still make money from the clothing store, and other way.

Personal Incentives

In some rare cases, a merger or an acquisition is initialised due to managers personal incentives in form of higher salary, benefits etc., and has nothing to do with strategic planning.

TRANSACTION CHARACTERISTICS

There are several methods of payment for an M&A activity described below.

  • Stock Purchase: This transaction requires acquirer to provide cash, stock, or combination of cash and stock in exchange for the shares of the company being acquired. This requires shareholders’ approval, since shares can’t be bought without their consent. Any gain made by the shareholders on their capital is taxed by the government.
  • Asset Purchase: This requires acquirer to buy all the target firm’s assets. The payment in made directly to the firm. This kind of transaction may not require shareholders’ approval/permission. Acquirer, in most cases, won’t assume the responsibility for firm’s liabilities, which would mean that the firm being acquired would have to settle the debt on its own.
  • Cash Offering: This kind of transaction simply requires payment in cash.
  • Security Offering: In this case, shareholders are given shares of common stock, preferred stock, or in some cases debt of the acquirer. The exchange ratio is calculated bases on number of securities in exchange for a share of target stock.

Factors influencing method of payment

There are various factors that need to be considered before method of payment is decided. The risk is usually shared among acquirer and target shareholders in a certain ratio. The ratio is decided based on financial standing of each company. Moreover, signaling by the acquiring firm is also important; they are in a much stronger position to dictate terms. Balance sheet and other financial documents are an immense help in ascertaining the capital structure of the acquiring firm, which becomes an important consideration when it comes to method of payment.

Another important consideration includes the financial leverage the acquirer enjoys. If the company is highly leveraged, more debt wouldn’t be recommended, and liability if the target company will not be assumed.

Attitude of Management

From the perspective of the board of directors of the target companies, the merger can be classified into two broad categories:

  • A friendly merger: This happens when the ‘board of directors’ agree, negotiate and finally accept an offer.
  • A hostile merger: This happens when the ‘board of directors’ attempt to prevent the merger.

In case of a hostile takeover, takeover defenses are used, with the intention to either prevent the transaction or increase the bid. Directors may trigger pre-offer mechanism, which makes the target company seem less attractive. This prevents the acquiring firm from making a decent offer. Alternatively, directors may try post-offer mechanism, which include addressing ownership of shares, hence reducing acquirer’s power gained from its ownership.

REGULATIONS AND OTHER HURDLES

Legal Due Diligence

It is an important exercise of an M&A transaction and helps both parties identify any legal risks associated with the merger. Due diligence also provides an opportunity to minimize those risks. At the initial stage, all corporate documents are thoroughly reviewed which include Articles of Association. It also covers aspects relating to registrations of company’s employees with the regulatory authorities. The second phase includes reviewing details related to company’s shareholders, financial liabilities, contractual rights and obligations.

There are several regulatory considerations when performing M&A. In some cases, there is a need to obtain specific approvals from an M&A transaction from government regulatory bodies, especially when the company is part of core economic activities of the country like banking, insurance, electricity or water supply. Some areas of economy require licenses and NOCs to collude. Additionally, government agencies exist that ensure industries stay competitive. M&A transactions usually present a possibility of collusion between firms, in order to raise price and create a monopoly situation. This situation generated extraordinary profits for the company, but exploits consumers, since they don’t have a choice and end up purchasing the goods at a higher price. Competition commissions exist on order to make sure that markets stay competitive. Some countries have foreign capital investment laws, which prevent foreign companies from investing locally or set a certain investment limit. There are no ways around these hurdles, which means that M&A transaction cannot be executed and finished.

As the firm grows in size after M&A transaction, a different set of tax brackets may be applicable. This needs to be takes into considerations since it could adversely impact company’s profits. Such a development will be irksome to shareholders and other stakeholders.

Labor Laws

Some countries have stringent labor laws, which need to be taken into account before M&A transaction take place. Big firms find themselves in spotlight when it comes to labor laws. The acquirer needs to understand how the labor laws are going to impact the company once the merger is complete. Moreover, the politics of labor unions also needs to be understood and reconciled with. Sometimes, the employees are not happy with the proposed merger, which could threaten to disrupt the operations of the company.

It must also be made sure that labor is not exploited under the new administration, which can be done by paying a fair wage, providing safe working condition and health insurance.

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4 comments

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1

Your article has shown the complete picture of merger and acquisition process. Merger is the process by which two companies join together with a new name to start new business. Companies involved are typically of similar size and stature. In acquisition, one business buys a second one or one smaller company is absorbed into the parent company. Acquisition process is beneficial for the company going in loss.

2

Great article, thanks for putting this together.

3

You're welcome, Kevin.

4

Great article