Mergers and Acquisitions

The term mergers and acquisitions (abbreviated to M&A) refers to the combining of two or more separate companies into one entity.

In reality, the ins and outs of M&A are far more complicated, and involve complex corporate strategy, corporate finance and management deals in the buying, selling and consolidation of separate firms.

What Are Mergers and Acquisitions?

Mergers and acquisitions operate within the field of corporate finance. M&A transactions form larger companies by merging two or more smaller ones.

The purpose of M&A is to allow growing companies to expand rapidly, through purchasing or joining forces with another business entity.

They are costly and complicated transactions that involve in-depth analysis and strategic negotiations. They also come with a number of legal and tax implications.

The term M&A is also used to identify departments in corporate institutions that manage these purchase deals on behalf of clients involved in a merger or acquisition.

How Do Mergers and Acquisitions Differ?

Although often used synonymously, the terms ‘merger’ and ‘acquisition’ have slightly different meanings:

Acquisition

In most instances, an acquisition will involve two parties:

• An acquiring company
• A target company

The acquiring company purchases the target company, cementing itself as the new owner by taking full control of all operations.

From a legal perspective, the target company no longer exists – its stock is removed from the market, while the acquiring company’s stock continues to be traded.

An acquisition can also involve the purchase of a specific department, product line or assets of a target company.

Merger

In its strictest definition, a merger is said to take place when two or more companies, usually of equal standing, strike a deal to move forward as one single entity.

All companies involved surrender their stock, and a new stock is issued under the newly formed legal company. This is referred to as a ‘merger of equals’.

In practice, actual mergers of equals are quite rare. Usually, a reported ‘merger of equals’ is still an acquisition, but the acquired firm has requested in the deal terms that they be allowed to state that the deal was a merger of equals.

Firms request this to avoid any negative press around the acquisition.

If the target company is amenable to its purchase, the transaction will often be referred to as a merger. If the takeover is hostile, it will be seen as an acquisition.

So, in reality, merger and acquisition difference really comes down to the parties involved, their individual view on the deal in question and how they communicate it to their stakeholders.

Why Do Mergers and Acquisitions Take Place?

The driving motivation behind the merger and acquisition process is to create shareholder value over and above that of the sum of two or more individual companies.

Dependent on the circumstances, shareholder value can be increased through a variety of potential benefits that come as part of a merger or acquisition:

Merger Synergies

Synergy is the term used to describe the concept that two companies are more valuable as one than as two separate entities.

It is based on the theory that a merger will result in revenue enhancement and cost savings through staff reductions and increased economies of scale.

Improved Market Reach and Industry Visibility

A successful merger can open up new sales opportunities, with the new company benefiting from extended marketing and distribution.

This allows the merged companies to reach new markets and, subsequently, increase revenue and earnings.

A merger can also increase a company’s ability to raise capital: bigger firms often attract more interest from investors than smaller companies.

Increased Capability

By merging to form a larger entity, companies can increase their capacity to acquire and successfully serve high-volume, high-profile clients.

By combining experience and expertise, and pooling resources, they can grow quickly and efficiently thanks to their newly acquired capabilities.

Acquisition of New Technology

New business applications and technological developments give companies a competitive edge.

By acquiring, or merging with, a company that holds unique technologies, businesses can become market leaders by surpassing their competition.

Diversification

Mergers and acquisitions allow companies to expand their product or service portfolio.

Developing and taking a new product or service to market requires a significant investment of both time and money. By acquiring an existing product or service line, companies can bypass the development stage and benefit from an already established market.

This diversification can also increase market visibility, generate increased sales and revenue, and help to spread potential risk.

Types of Mergers and Acquisitions

As a general rule, the way a merger takes place – or more specifically, the way it is financed – will fall into one of two categories:

• Purchase mergers – These are essentially acquisitions. Company A will purchase company B, either with cash or through the issue of some kind of debt instrument. This is the preferred method for most acquiring companies, as it can provide them with a tax benefit.
  
  
• Consolidation mergers – The truer definition of a merger, consolidation deals require the formation of a new company that purchases both the merging companies. So, company A is formed and purchases companies B and C, who now operate together as the new legal entity of company A.

In terms of business structure, there are several ways in which two or more companies can merge. The difference between these is relative to the relationship between the existing companies and the fields in which they operate:

• Horizontal mergers – Companies A and B are direct competitors in the same market. They merge to increase their overall market share, take advantage of economies of scale and, in theory, reap the benefits of merger synergies.
  
  
• Vertical mergers – Companies A and B operate at different points in the supply chain. By merging, they are aiming to increase the efficiency and financial gain of production and/or distribution. In theory, the merger should result in better quality control, effective communication and merger synergies.
  
  
• Market extension mergers – Companies A and B offer the same products or services but do so in different territories. They merge to expand their potential market and subsequently gain a larger client base.
  
  
• Product extension mergers – Companies A and B operate in the same market and offer related products or services. In merging, they expand their offerings with the aim of gaining greater market access. As their products or services are related, they will also often use similar production and distribution channels, and look to capitalise on this through their merger.
  
  
• Conglomerate mergers – Companies A and B operate in completely unrelated industries and (potentially) different market territories. While they have nothing in common, they may merge to diversify their product or service portfolio, and gain a foothold in new corporate sectors.

Although the above are all described as ‘mergers’, as already discussed, in most instances they will take the form of an acquisition, albeit under the guise of a merger. This is particularly true of conglomerate mergers.

In order to undertake any kind of purchase deal, businesses will use the services of mergers and acquisitions companies.

What Do M&A Firms Do?

The term ‘M&A’ is also used to identify the departments of financial and corporate businesses that handle the complex transactions that take place as part of the mergers and acquisitions process.

There are several types of M&A companies, each with their own specialist areas:

Investment Banks

Investment banks play a significant role in corporate restructuring, and are often heavily involved in the M&A process.

An investment bank will handle the financial aspects of a purchase deal. Dependent on the circumstances, they may be enlisted to provide crucial market insight, and compile a list of possible targets on behalf of an acquiring company.

Once a target company has been selected, the investment bank will carry out an in-depth valuation relative to how the purchase will be financed.

Representatives of the investment bank will act on behalf of the acquiring company, negotiating terms, managing all financial documentation and closing the deal. Accounting and legal aspects are usually outsourced.

An investment bank may also act on behalf of a company that wishes to sell. In that case, they will carry out an auction to obtain the highest possible bid on behalf of their client.

Audit and Accounting Firms

The collective companies known as the ‘Big Four’ (Deloitte, PwC, EY and KPMG) are examples of accounting firms that specialise in the M&A process.

The role of these firms is predominantly to evaluate the assets of a target company, carry out audits and advise the acquiring company on any relevant tax implications.

Audit and accounting firms are particularly vital for cross-border deals, as tax considerations become more complex.

While these mergers and acquisitions companies specialise in the accounting, auditing and taxation aspects of purchase deals, they often have additional departments or subsidiaries that can take on the financial side of the process.

Law Firms

For companies that wish to expand on an international scale, law firms are a common choice for the handling of the M&A process.

When an acquiring company looks to purchase a target company that operates across an international border, the legal aspects of the deal become more complex, as the target company will be subject to a separate set of laws governed by the relevant jurisdiction.

Consulting and Advisory Firms

Consulting and advisory firms manage all aspects of the M&A process. They work on behalf of their clients, advising on strategic growth strategies and conducting the initial screening of potential target companies.

They carry out all due diligence and work to ensure the accuracy of valuations, to close the best deals for the acquiring companies.

The larger consulting and advisory firms that specialise in M&A operate on a global level, allowing them to effectively manage both cross-border and cross-industry purchase deals.

Final Thoughts

Mergers and acquisitions are costly and complex business transactions that are not always successful.

There are government rules and regulations in place, to protect fair competition and prevent monopolisation in any given industry.

Regardless, the M&A process is a huge part of the corporate finance world and, when successful, it allows companies to grow quickly and efficiently through strategic restructuring.