Mergers and Acquisitions

This article has been written by Navneet Chandra, a student of Central University of South Bihar, Gaya

Introduction

Mergers and acquisitions, or M&A for short, involves the process of combining two companies into one. The goal of combining two or more businesses is to try and achieve synergy – where the whole (new company) is greater than the sum of its parts (the former two separate entities).

What are Mergers and Acquisitions?

Mergers occur when two companies join forces. Such transactions typically happen between two businesses that are about the same size and which recognize advantages the other offers in terms of increasing sales, efficiencies, and capabilities. The terms of the merger are often fairly friendly and mutually agreed to and the two companies become equal partners in the new venture.

Acquisitions occur when one company buys another company and folds it into its operations. Sometimes the purchase is friendly and sometimes it is hostile, depending on whether the company being acquired believes it is better off as an operating unit of a larger venture. The end result of both processes is the same, but the relationship between the two companies differs based on whether a merger or acquisition occurred.

Forms of Acquisition

There are two basic forms of mergers and acquisitions (M&A):

1. Stock purchase

In a stock purchase, the acquirer pays the target firm’s shareholders cash and/or shares in exchange for shares of the target company. Here, the target’s shareholders receive compensation and not the target. There are certain aspects to be considered in a stock purchase:

The acquirer absorbs all the assets and liabilities of the target – even those that are not on the balance sheet.

To receive the compensation by the acquirer, the target’s shareholders must approve the transaction through a majority vote, which can be a long process.

Shareholders bear the tax liability as they receive the compensation directly.

2. Asset purchase

In an asset purchase, the acquirer purchases the target’s assets and pays the target directly. There are certain aspects to be considered in an asset purchase, such as:

Since the acquirer purchases only the assets, it will avoid assuming any of the target’s liabilities.

As the payment is made directly to the target, generally, no shareholder approval is required unless the assets are significant (e.g., greater than 50% of the company).

The compensation received is taxed at the corporate level as capital gains by the target.

Types of Mergers and Acquisitions

Merger or amalgamation may take two forms: merger through absorption or merger through consolidation. Mergers can also be classified into three types from an economic perspective depending on the business combinations, whether in the same industry or not, into horizontal (two firms are in the same industry), vertical (at different production stages or value chain) and conglomerate (unrelated industries). From a legal perspective, there are different types of mergers like short form merger, statutory merger, subsidiary merger and merger of equals.

Benefits of Combining Forces

Some of the benefits of M&A deals have to do with efficiencies and others have to do with capabilities, such as:

Improved economies of scale. By being able to purchase raw materials in greater quantities, for example, costs can be reduced.
Increased market share. Assuming the two companies are in the same industry, bringing their resources together may result in larger market share.
Increased distribution capabilities. By expanding geographically, companies may be able to add to their distribution network or expand its geographic service area.
Reduced labour costs. Eliminating staffing redundancies can help reduce costs.
Improved labour talent. Expanding the labour pool from which the new, larger company can draw can aid in growth and development.
Enhanced financial resources. The financial wherewithal of two companies is generally greater than one alone, making new investments possible.

Potential Drawbacks

Although mergers and acquisitions are expensive undertakings, there are potential rewards. And there are disadvantages, or reasons not to purchase an acquisition, including:

Large expenses associated with buying a company, especially if it does not want to be acquired. (If an investor has a controlling interest in another company, however, it may not have a choice regarding whether it is acquired.)
Higher legal costs, which can be exorbitant if a company does not want to be acquired.
The opportunity cost of having to forego other deals in order to focus on bringing two companies together.
The possibility of a negative reaction to a merger or acquisition, which drives the company’s stock price lower.

M&A is a growth strategy corporation often use to quickly increase its size, service area, talent pool, customer base, and resources in one fell swoop. The process is costly, however, so the businesses need to be sure the advantage to be gained is substantial.

Steps Involved in M & A Transactions

Phase 1: Pre-acquisition review: this would include self-assessment of the acquiring company with regards to the need for M&A, ascertain the valuation (undervalued is the key) and chalk out the growth plan through the target.

Phase 2: Search and screen targets: This would include searching for the possible apt takeover candidates. This process is mainly to scan for a good strategic fit for the acquiring company.

Phase 3: Investigate and valuation of the target: Once the appropriate company is shortlisted through primary screening, detailed analysis of the target company has to be done. This is also referred to as due diligence.

Phase 4: Acquire the target through negotiations: Once the target company is selected, the next step is to start negotiations to come to consensus for a negotiated merger or a bear hug. This brings both the companies to agree mutually to the deal for the long term working of the M&A.

Phase 5: Post merger integration: If all the above steps fall in place, there is a formal announcement of the agreement of merger by both the participating companies.

Conclusion

M&A’s are considered as important change agents and are a critical component of any business strategy. The known fact is that with businesses evolving, only the most innovative and nimble can survive. That is why, it is an important strategic call for a business to opt for any arrangements of M&A. Once through the process, on a lighter note M&A is like an arranged marriage, partners will take time to understand, mingle, but will end up giving positive results most of the times.

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