A Comprehensive Guide To Merger And Acquisition (With Types)
By Indeed Editorial Team
Updated 7 September 2022
Published 16 May 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Mergers and acquisitions are transactions that businesses use to change ownership and consolidate their position in a market. While both transactions have similarities, mergers differ from acquisitions. Understanding how mergers and acquisitions work can help organisations increase their market access and boost profits. In this article, we explore the meaning of merger and acquisition, outline their common types and discuss how these business agreements work.
What Do The Words Merger And Acquisition Mean?
Merger and acquisition are both business development strategies that involve a set of processes and happen over a period of time ranging from a few months to a few years. When a company has excess financial resources and wants to improve its market share value, it may choose to merge with or acquire another business entity. Mergers and acquisitions allow businesses to consolidate their resources, workforce and products. While a merger involves two or more business entities coming together to form a new singular entity, an acquisition often involves a larger company absorbing a smaller company.
Companies go into mergers by making arrangements that are mutually beneficial for all involved parties. An acquisition may in contrast benefit only the larger business entity. In a merger, the resultant company sells the stock of the merging companies under its new name. The stock of the merging business entities ceases to exist after the merger. In an acquisition, the volume of stock options of the larger business entity or the acquirer typically increases without a change in its name. Mergers and acquisitions can drastically affect the stock value of companies.
Types Of Mergers And Acquisitions
These are some common examples of transactions that classify under mergers and acquisitions:
Types of mergers
These are some common types of mergers:
Horizontal merger: This involves the merging of two entities in the same industry. Horizontal mergers often involve competitors who want to capture a larger market share, enjoy merger synergies and achieve economies of scale.
Vertical merger: This is a merger between two businesses that sell different products but share common supply chains. The aim of this transaction is to improve efficiency.
Conglomerate merger: The process where two companies that share no similarities become one to reduce risk, share assets and benefit from the scale is called a conglomerate merger. In a pure conglomerate merger, the merging entities may be unrelated and may serve in different markets.
Market extension merger: This involves the merger of two companies in the same industry but different markets to gain a larger number of customers. The companies usually sell the same products or services, so the merger generates a larger client base.
Product extension merger: This merger involves two entities selling related products in the same industry. The aim of the merger is to allow the two companies to group their products together to increase market access and profits.
Types of acquisitions
These are examples of transactions that classify as acquisitions:
Consolidating acquisition: Consolidating acquisition is the process where an acquiring company buys another company to decrease competition.
Value creating acquisition: This type of acquisition is where an entity buys a business operation to make a profit. Rather than absorbing the target company, the acquirer enhances the firm's performance and sells it to the highest bidder.
Accelerating acquisition: This involves a bigger company buying a smaller business to increase the market access of the target company's products or services.
Speculating acquisition: This is when a larger entity buys a smaller business to gain from the potential growth of the acquired company's new products or services.
Resource acquiring acquisitions: This involves an acquisition in which a company buys another company to have access to the acquired firm's resources such as intellectual property, skills, personnel or market access. The rationale behind this transaction is that the acquirer can save cost and time if it buys an existing company with the required structure, rather than creating a new one.
How Do Mergers And Acquisitions Work?
Mergers and acquisitions are lengthy and systematic processes that typically happen in a series of stages. The stakeholders of business entities involved in such a business transaction may conduct several rounds of negotiations before they identify mutually beneficial terms for the business arrangement. Typically, the senior stakeholders of the larger business entity make the first deliberations in a merger or acquisition. These are some of the important steps in a merger:
1. Creating a strategy for the merger or acquisition
One of the first steps involved in a merger or acquisition is creating effective strategies to direct and manage the overall process of the transaction. Legal and financial professionals under the supervision of management staff and stakeholders may create documents to guide negotiations and agreements between the merging companies. These documents define the purpose of the merger, strategies to convince stakeholders, potential benefits of the arrangement and strategies for acquiring the required funding.
2. Identifying parameters for target companies
After identifying and finalising a strategy, stakeholders may meet and discuss to identify the criteria for preparing a list of target companies. The exact criteria may vary from company to company and typically depends on their relevant business needs. For example, a company's stakeholders may prepare a list of target companies based on their online presence, geographic reach, supply chain efficiency, customer base, size or market share percentage.
3. Identifying suitable target companies
After preparing a list of companies that fit the criteria, stakeholders may evaluate the pros and cons of engaging in a business arrangement with each of the target companies. Financial analysts and business analysts typically assist senior management staff and stakeholders to evaluate the financial performance, market performance and growth potential of individual target companies. Keeping the best interests of their client in mind, they may prepare a list of ideal target companies to go into a merger with.
4. Planning the merger or acquisition
After identifying potential targets, the larger company contacts the target companies with their initial offer for the merger or acquisition. The response of a target company typically decides whether the business transaction proceeds as a merger or an acquisition. Some target companies may respond in a friendly way to try and facilitate a mutually beneficial merger. Others may not respond positively, and the larger company may then consider the possibility of a hostile takeover or acquisition.
Valuation is a process through which professionals estimate the financial value of a business operation. When calculating the valuation of a company, professionals usually consider its performance, infrastructure, brand image, products, market share, human resources, intellectual property and financial capital. Valuation is important for understanding the financial performance and growth prospects of a company. The larger company's stakeholders use this information to guide business decisions related to a merger or acquisition.
If stakeholders of the larger company are content with the results of valuation, they may engage in negotiations with stakeholders of their target companies. Target company stakeholders can also negotiate to secure a more beneficial deal. For example, the stakeholders of a target company may negotiate for a lower value merger, to retain control of their company assets. In a higher value acquisition, individual profits for stakeholders may be high, but at the cost of forgoing company assets.
Auditing involves comprehensively analysing the acquirer's valuation of the target company. Auditors verify the target company's financial situation, customer and client base, market share, human resources, production capacity and other important variables. The aim of auditing is to ensure that the acquirer makes a correct valuation and to prevent financial crimes and fraud.
8. Preparing purchase and sale agreements
If auditing reveals no errors in valuation, executives or legal and finance professionals prepare purchase and sale agreements for the stakeholders of invested business entities to sign. After stakeholders sign the acquisition contract, assets and shares of the target company are transferred to the acquiring company. In the case of a merger, the assets and shares are transferred to a new business entity, typically under a new name.
9. Establishing a strategy for financing the arrangement
Before or after invested parties sign the agreement, the acquirer company may disclose its strategy for financing the business arrangement. In the event of an acquisition, businesses with good credit scores can secure loans from financial institutions to pay a lump sum amount to the target company stakeholders. In some cases, the acquirer transfers the total payable amount in the form of monthly, quarterly or yearly instalments over a period of a few years. Stakeholders can also choose to hold stock options in business entities that are resultant of a merger or acquisition.
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