If you’ve been researching mergers and acquisitions, you’re probably overwhelmed with all the jargon and the many considerations for a successful deal.
Don’t worry – I’m here to help! As a professional financial consultant with over 15 years of experience helping companies strategize, plan and execute their mergers and acquisitions, I understand what it takes to demystify the complexities of mergers and acquisitions.
In this article, I will explain exactly what mergers and acquisitions are and provide you with key information so that you can make informed decisions.
Whether you’re an individual looking to make an informed decision, or a business owner weighing up your options, my goal is to make these complicated topics easier to understand.
Let’s get started!
- Mergers and Acquisitions combine two or more companies into one entity.
- M&A typically involves a purchase agreement where one company acquires another
- The purpose of an M&A is to increase revenue, expand operations, gain market share, acquire talent, or create economies of scale.
- The process requires due diligence, financial analysis, and legal documents.
- M&A is a complex process that requires strategic planning and foresight
Mergers and Acquisitions Overview
Mergers and Acquisitions (M&A) is a general term encompassing various transactions involving the transfer of ownership of a business or entity from one entity to another.
While each acquisition may vary in specifics, most deals will involve an offer price between the two entities and due diligence tasks such as:
- auditing finances
- setting up tax structures
- and placing valuations on assets and liabilities.
Generally, M&A transactions involve large corporations that purchase one or smaller, established companies to extend their operations or increase their market presence.
Types of Mergers and Acquisitions
Several types of Mergers and Acquisitions can occur in an M&A transaction.
From horizontal mergers, vertical mergers, and conglomerate mergers, each deal has its own advantages and disadvantages to consider.
Let’s take a closer look at the various types of M&A.
Mergers involve the union of two organizations into one.
When two corporations join forces, they typically seek to create greater economies of scale or expand their reach in a certain industry or geographic area.
The newly merged organization is responsible for a larger market share and can use this to increase prices on its products or services to generate more revenue.
Acquisitions involve the purchase of one company by another. An acquisition can be either friendly or hostile, depending on the circumstances.
In a friendly acquisition, the target company will usually agree to the sale.
A hostile acquisition is more likely when there is opposition from management or shareholders of the target company.
Consolidations involve combining two or more related companies, typically in the same industry.
The goal of consolidation is to help reduce operating costs, consolidate resources, and increase market share for the combined entity.
Tender offers involve a company offering to purchase the stock of another company at a certain price.
Businesses make tender offers to gain control of a significant portion of the target company’s shares or assets.
Acquisition of Assets
Acquisition of assets involves the purchase of one company’s assets by another, with no transfer of ownership.
The acquiring company takes control of the target’s assets and liabilities, while the original owner retains ownership.
Companies use this transaction to acquire specific resources from another, such as patents, trademarks, or technology.
A management acquisition is when an individual or group purchases a controlling stake in a company.
This type of M&A allows management to take control of their destiny and make decisions in the best interest of their business.
The benefit for investors is that there may be a potential upside if the new management team can turn around the company’s fortunes.
Who Handles M&A In a Company?
A company’s finance department typically handles mergers and acquisitions.
This team will be responsible for managing the M&A, including conducting due diligence, negotiating the terms of the sale, and closing the deal.
Depending on the size of the transaction, external advisors such as attorneys or investment bankers may also provide additional expertise.
Who Approves Company Mergers?
Mergers between companies are complex processes that require approval by the stakeholders of a target company.
Typically, a majority of the outstanding shares of the company must agree to the merger for it to go through.
Merger review is usually handled jointly by two governmental agencies- The Federal Trade Commission (FTC) and the Department of Justice (DOJ).
Depending on the industry involved, one agency or another may be more suited to assess the prerequisites and conditions necessary for approval.
As such, each case is looked at independently and can sometimes involve both agencies if deemed necessary.
How are Mergers and Acquisitions Structured?
There are various structures of mergers and acquisitions, depending on the business transaction.
Now that we have discussed what mergers and acquisitions are, how it works, and who is responsible for handling M&A transactions, let’s look at the different structures.
Vertical mergers represent a strategic business decision increasingly popular in today’s competitive marketplace.
By personally integrating two or more industry-related companies, the result is:
- simplified operations
- control of the respective production process
- an overall better ability to serve customer needs
- boosted profitability
- lower costs
- reduced redundancies
- access to previously unavailable resources and technology
It is also often pursued the purpose of cost savings and improved market perception as major players in their respective fields.
Horizontal mergers refer to transactions where two entities in the same industry merge.
Unlike vertical mergers, which involve companies with related but distinct products or services, horizontal ones involve competitors combining forces to create a larger and more powerful enterprise.
Horizontal mergers can increase revenue and market share for the merged entity while reducing competition in the market, often leading to higher prices for consumers.
Congeneric mergers occur when companies in related but distinct industries merge.
For example, a manufacturer of automotive parts combined with an auto dealer may constitute such a transaction.
Companies pursue these deals to:
- Diversify their portfolio
- Gain access to different customer segments
- Gain entry into a new market.
The main risks of such transactions are cultural differences which create the potential for miscommunication or ill-advised investments due to a lack of expertise in the acquired company’s sector.
Market Extension Merger
A market extension merger is a great tool for companies looking to grow their business.
By merging with another company in an adjacent market, the merging companies can get access to new customers who may have previously been off-limits.
This helps them:
- Increase sales
- Reduce costs
- Increase brand recognition
- Increase overall dominance of the market
- Improve manufacturing efficiencies
- Create better pricing structures through economies of scale
- and provide additional resources in areas where they may be lacking
Product Extension Merger
Product extension mergers are a win-win situation for business organizations that operate in the same market.
By merging their products, companies can provide customers with an even better variety of products than they had before – and get access to an entirely new level of customer base as well.
Furthermore, it allows them greater access to resources such as trained personnel and openings for investment.
Completing a product extension merger can strategically increase profits for everyone involved – so it is no wonder this type of merger is becoming increasingly popular among businesses worldwide!
Conglomeration mergers are the most complex and challenging of all M&A transactions.
They combine companies with different products, services, and/or markets.
However, when done correctly, a conglomerate merger can open up a world of possibilities for merged entities.
By melding together unique resources and skill sets, companies can:
- create entirely new products
- enter into highly profitable markets
- and gain greater control over their supply chains.
How are Mergers and Acquisitions Financed?
When it comes to financing Mergers and Acquisitions, companies can consider a few different options.
Each option has advantages and disadvantages; however, each offers an effective way of raising capital for the transaction.
Next, we’ll look at each financing option in more detail to help you determine which one best fits your needs.
A stock purchase is one of the most common ways to finance a merger or acquisition. When two companies merge, the new company can issue stock to pay for the other’s shares.
This means both companies will own parts of each other, allowing them to share ownership and resources.
An asset purchase is when one company purchases the assets of another, such as its:
- Product line
- Or intellectual property
This financing allows the acquirer to avoid some of the liabilities of buying a company outright while still taking advantage of the target’s strengths to increase their profits.
Payment is another way to finance a Merger or Acquisition. This method involves the acquirer paying cash or issuing debt in exchange for the target company’s assets and liabilities.
Depending on the terms of the deal, this can result in either an immediate payment or a deferred payment.
A few common methods of payment for this type of financing include:
- Cash payments
- Stock purchases
- Debt financing
- Asset exchanges
- Equity swaps
- Earnouts/contingent payments.
How are Mergers and Acquisitions Valued?
Now that we know the different ways to finance a Merger or Acquisition, understanding how these deals are valued is equally important.
Let’s look at how to determine the value of an M&A deal.
P/E Ratio (Price to Earnings Ratio)
The most common method to value a Merger or Acquisition is the Price to Earnings Ratio (P/E Ratio).
This ratio compares the target company’s current market price and its expected earnings for the next 12 months, giving buyers an idea of how much they should be willing to pay for the company.
EV/Sales (Enterprise Value to Sales Ratio)
The Enterprise Value to Sales Ratio (EV/Sales) is another way to value a Merger or Acquisition.
This ratio compares the target company’s total enterprise value and its expected sales for the next 12 months, giving buyers an indication of how much they should pay for the business.
DCF (Discounted Cashflow)
The Discounted Cashflow (DCF) method is a more complex approach to valuing Mergers and Acquisitions.
This method considers both the current cash flow of the target company and its expected future cash flows, which discount back to today’s value.
Reasons for Mergers and Acquisitions
Mergers and Acquisitions are complex transactions requiring much thought and research. However, they can also benefit both companies if done correctly.
Let’s take a look at some of the reasons why corporations choose to pursue M&A deals.
Perhaps the most common reason companies pursue Mergers and Acquisitions is to unlock synergies between the two companies.
By combining the strengths of both businesses, they can create greater efficiencies and increase their profits.
Another common reason companies pursue Mergers and Acquisitions is to gain access to new markets or products they may not have had access to otherwise.
As they tap into these new opportunities, this can lead to higher growth potential for both businesses.
Stronger Market Power
Mergers and Acquisitions can also help companies build stronger market power.
By combining the two companies, they can gain more leverage against their competitors and capture a larger market share.
Mergers and Acquisitions can also help companies diversify their portfolios.
By combining different businesses, they can spread out their risks and reduce the volatility of their investments.
Finally, companies may pursue Mergers and Acquisitions to gain tax benefits.
Combining two businesses can reduce their overall tax liability and increase their profits.
Mergers and Acquisitions Examples
As of November 2022, the record for the largest acquisition ever made still stands at $203 billion for Vodafone’s takeover of Mannesmann in 2000.
The UK-based mobile operator joined forces with the German industrial conglomerate company to create a leading mobile telecommunications powerhouse.
This mega deal cemented Vodafone’s status as the world’s largest mobile provider and inspired similar transactions across multiple industries.
Although there have been other significant acquisitions since then, this incredible feat remains the biggest in history.
Mergers and Acquisitions are complex transactions requiring much thought and research.
However, when done correctly, they can benefit both companies involved.
Now we’d like to hear from you; have you ever been involved in an M&A transaction? What tips would you give to those considering one? Let us know in the comments below!