Companies merge for the sole
purpose of increasing their shareholders value over and above that of the sum
of the individual companies, i.e. 1+1 > 2. This rationale is particularly
alluring to companies when times are tough. Strong companies will act to buy
other companies to create a more competitive, cost efficient company. The
companies will come together hoping to gain a greater market share or to
achieve greater market share or to achieve greater efficiency. Because of these
potential benefits, target companies will often agree to be purchased when they
know they can’t survive alone. There are numerous factors that contribute to
the success or failure of the acquisition.
A merger is a corporate
strategy of combining different companies into a single company in order to
enhance the financial and operational strengths of both organizations.
A merger usually involves
combining two companies into a single larger company. The combination of the
two companies involves a transfer of ownership, either through a stock swap or
a cash payment between the two companies. In practice, both companies surrender
their stock and issue new stock as a new company.
Horizontal Merger – This kind of merger exists between two companies who compete in
the same industry segment. The two companies combine their operations and gains
strength in terms of improved performance, increased capital, and enhanced
profits. This kind substantially reduces the number of competitors in the
segment and gives a higher edge over competition.
Vertical Merger – Vertical merger is a kind in which two or more companies in the
same industry but in different fields combine together in business. In this
form, the companies in merger decide to combine all the operations and
productions under one shelter. It is like encompassing all the requirements and
products of a single industry segment.
Co-Generic Merger – Co-generic merger is a kind in which two or more companies in
association are some way or the other related to the production processes,
business markets, or basic required technologies. It includes the extension of
the product line or acquiring components that are all the way required in the
daily operations. This kind offers great opportunities to businesses as it
opens a hue gateway to diversify around a common set of resources and strategic
Conglomerate Merger – Conglomerate merger is a kind of venture in which two or more
companies belonging to different industrial sectors combine their operations.
All the merged companies are no way related to their kind of business and
product line rather their operations overlap that of each other. This is just a
unification of businesses from different verticals under one flagship
enterprise or firm.
A corporate action in which a
company buys most, if not all, of the target company’s ownership stakes in
order to assume control of the target firm. Acquisitions are often made as part
of a company’s growth strategy whereby it is more beneficial to take over an
existing firm’s operations and niche compared to expanding on its own.
Acquisitions are often paid in cash, the acquiring company’s stock or a
combination of both.
The following are the types
Stock Purchase – The acquirer buys the seller’s stocks from shareholders, all
assets and liabilities and off-balance sheet items as well. Book values are used
for valuation of assets and liabilities, which can be modified as well for any
step-ups or step-downs. This type of acquisition is inexpensive and quick to
execute; it is mostly preferred by the seller and is popularly used for
acquiring public or large companies.
Asset Purchase – Here, the buyer gets to choose the assets he wants to acquire
and liabilities that he wants to assume; these have to be clearly defined in
the purchase agreement. In asset purchase, every single asset / liability must
be valued separately before the transfer takes place; this makes the process
complex as well as time- consuming. Asset purchase gives the buyer greater
flexibility to choose, therefore it is preferred by the acquirer. Private
companies commonly use this kind of acquisition and it’s also used for
divestitures and distressed sales.
Why Companies Merge and
There are numerous reasons
why one company chooses to merge with or acquire another. The rationales
consist of the higher-level reasoning that represents decision conditions under
which a decision to merge could be made. Drivers are mid-level specific (often
operational) influences that contribute towards the justification or otherwise
for a merger. As an example, company A might decide to acquire company B. The
underlying rationale could be that of strategy implementation. In order to
achieve one or more strategic objectives, it may be necessary for company A to
acquire company B because, at present, there is over-capacity in the sector in
which company A and company B operate. This is an example of a strategic
rationale. The underlying driver for acquiring company B is the desire to
control capacity in that sector.
An understanding of the
various rationales and drivers behind mergers and acquisitions is very
important in developing command of this text.
Some Underlying Rationales:
There are several primary
rationales that determine the nature of a proposed merger or acquisition. These
Strategic rationale – The strategic rationale
makes use of the merger or acquisition in achieving a set of strategic
objectives. Mergers and acquisitions are usually not central in the achievement
of strategic objectives, and there are usually other alternatives available.
For example, company A might want to gain a foothold in a lucrative new
expanding market but lacks any experience or expertise in the area. One way of
overcoming this may be to acquire a company that already has a track record of
success in the new market. The alternative might be to develop a research and
development division in the new market products in an attempt to catch up and
overtake the more established players.
This alternative choice has
obvious cost and time implications. In the past it has only really been
achieved successfully where the company wishing to enter the new market already
produces goods or has expertise in a related area. As an example, an
established producer of electronic goods might elect to divert some of its own
resources into developing a new related highly promising area such as digital
telephones. A large scale example is the electronics giant Sony in taking the
strategic decision to create a research and development facility in electronics
games consoles in order to develop a viable competitive base in this area
despite there being a relatively small number of very powerful and established
competitors in the area. The strategic rationale may also be fundamentally
defensive. If there are several large mergers in a particular sector, a non-
merged company may be pressured into merging with another non-merged company in
order to maintain its competitive position. This strategic scenario tends to
happen in sectors dominated by relatively large players.
Speculative rationale – The speculative rationale
arises where the acquirer views the acquired company as a commodity. The
acquired company may be a player in a new and developing field. The acquiring
company might want to share in the potential profitability of this field
without committing itself to a major strategic realignment. One way to achieve
this is to buy established companies, develop them, and then sell them for a
substantial profit at a later date. This approach is clearly high risk, even if
the targets are analysed and selected very carefully. A major risk,
particularly in the case of small and highly specialised targets, is that a
significant proportion of the highly skilled people who work for the target may
leave either before, during or immediately after the merger or acquisition. If
this does happen the actual (rather than apparent) value of the target could
diminish significantly within a very short time. Another form of speculative
rationale is where the acquirer purchases an organisation with the intention of
splitting the acquired organisation into pieces and selling these, or major
parts of them, for a price higher than the cost of acquisition. The speculative
rationale is also high risk in that it is very vulnerable to changes in the
environment. Apparently attractive targets, purchased at inflated (premium)
cost, may soon diminish significantly in value if market conditions change.
Management failure rationale – Mergers or acquisitions can
sometimes be forced on a company because of management failures. Strategies may
be assembled with errors in alignment, or market conditions may change
significantly during the implementation timescale. The result may be that the
original strategy becomes misaligned. It is no longer appropriate in taking the
company where it wants to go because the company now wants to go somewhere
else. Such strategy compromises can arise from a number of sources including
changing customer demand and the actions of competitors. In such cases, by the
time the strategy variance has been detected, the company may be so far off the
new desired strategic track that it is not possible to correct it other than by
merging with or acquiring another company that will assist in correcting the
Financial necessity rationale
and acquisitions are sometimes required for reasons of financial necessity. A
company could misalign its strategy and suddenly find that it is losing value
because shareholders have lost confidence. In some cases, the only way to
address this problem is to merge with a more successful company or to acquire
smaller more successful companies.
Political rationale – The impact of political
influences is becoming increasingly significant in mergers and acquisitions. In
the UK between 1997 and 2002, the government instructed the merger of a number
of large government departments in order to rationalise their operations and
reduce operating costs. Government policy also encouraged some large public
sector organisations to consider and execute mergers. These policies resulted
in the merger of several large health trusts (hospitals financed by central
government but under their own management control). By 2002 several large
universities were also considering merging as a result of changes in government
funding policy. In Australia, some of the ‘big four’ banks embarked on an
aggressive overseas acquisitions policy because legislation in Australia
directly prevented them from merging with each other.
The difference between
Mergers and Acquisitions:
Although they are often used
synonymously, the terms merger and acquisition mean slightly different things.
When one company takes over another and clearly established itself as the new
owner, the purchase is called an acquisition. From a legal point of view, the
target company ceases to exist, the buyer “swallows” the business and
the buyer’s stock continues to be traded.
In the pure sense of the
term, a merger happens when two firms, often of about the same size, agree to
go forward as a single new company rather than remain separately owned and
operated. This kind of action is more precisely referred to as a “merger
of equals.” Both companies’ stocks are surrendered and new company stock
is issued in its place. For example, both Daimler-Benz and Chrysler ceased to
exist when the two firms merged, and a new company, DaimlerChrysler, was
In practice, however, actual
mergers of equals don’t happen very often. Usually, one company will buy
another and, as part of the deal’s terms, simply allow the acquired firm to
proclaim that the action is a merger of equals, even if it’s technically an
acquisition. Being bought out often carries negative connotations, therefore,
by describing the deal as a merger, deal makers and top managers try to make
the takeover more palatable.
A purchase deal will also be
called a merger when both CEOs agree that joining together is in the best
interest of both of their companies. But when the deal is unfriendly – that is,
when the target company does not want to be purchased – it is always regarded
as an acquisition.
Whether a purchase is
considered a merger or an acquisition really depends on whether the purchase is
friendly or hostile and how it is announced. In other words, the real
difference lies in how the purchase is communicated to and received by the
target company’s board of directors, employees and shareholders.
Merger and Acquisition
Phase I: Preparation Stage
Merger & Acquisition
process begins when an Engagement Agreement is signed. A successful analysis of
the goals and requirements depends upon a strong working relationship among all
the parties affected by the sale of a company. In concert with the company’s
advisors, i.e. Board of Directors, Accountant, etc. This helps the companies to
evaluate their needs and concerns in order to achieve your vision while
maintaining strict confidentiality. Following are the key steps for this
Market Research, Analysis,
and Strategy –
Serious buyers want documented, defensible evidence of your company’s
income-generating potential. The company’s own financial projections over three
to five years are desirable. A credible overview must include a complete
analysis of trends within your industry, competitor’s strengths and weaknesses,
and local and/or national influences on markets relevant to the industry.
2. Valuation – One of the key components
of the business-sale strategy is the valuation – what your company is worth. A
number of valuation methodologies are used today, and each is in compliance
with the standards set forth by a variety of government organizations. Some
valuations include a proprietary method of calculation of the discount rate
used in the income value method. However, a strategic buyer may be willing to
pay a premium beyond a standard valuation to acquire a unique competitive
advantage your company may provide. Only an experienced professional can help
to consider all the factors and possible methodologies to arrive at a maximum
Phase II: The Decision to
Confidential Business Review – A cogent document is
prepared that positively presents the company history and persuasively
demonstrates your company’s earning potential. This document, the Confidential
Business Review (CBR), must present the facts about the company in a way that
is meaningful to buyers, most of whom review sophisticated corporate documents
on a regular basis. The CBR generally does this without disclosing price or
terms, although every case is different.
Identification of Synergistic
The ability to reach qualified buyers quickly is vital, since market and
industry factors can change overnight, and thus influence the terms and final
sale price of your company. Examination of many potential buyers to find those
candidates who demonstrate a synergy with your company through their business
mission, employees, corporate culture and competitive strategies. A
Confidential Business Profile is prepared which gives a highly focused snapshot
of the business while retaining Confidentiality.
3. Confidential Approach to
Qualified Prospects – Confidentiality is the critical operative word in honing down a
list of buyer candidates. The dissemination of the business-sale information
must be handled confidentially. Targeted companies, which may include
competitors, are required to undergo an intensive screening process. Potential
buyers must sign a Confidentiality Agreement before they can receive a CBR.
Once the CBR’s are disseminated, the process of further qualifying prospects to
arrive at the most desirable candidates requires years of experience and proven
negotiations and techniques. Buyers have their own attorneys and board of
directors to assist them through the process.
4. Negotiations – The ideal negotiating
scenario for you will begin with multiple, fully- qualified buyers. This
permits an auction type of atmosphere which tends to maximize the sale price.
Still, negotiating with buyers, who are most likely expert deal-makers
themselves, requires seasoned professionals, specialists who understand how to
focus on value as opposed to price.
5. Deal Structuring, Letter
of Intent –
Once a serious buyer(s) is/are identified, the price, terms and other details
of a final deal are hammered out. A Letter of Intent (LOI) is the formal
document used to set forth the major transaction terms, confirmed in writing in
order to prevent misunderstandings. The LOI must put to rest any outstanding
issues concerning key employees, financing, legal matters, taxes, etc. It
should also be constructed to protect you from buyer delays which can cause you
to miss the window of opportunity for your sale.
6. Due Diligence – During this step of the
M process, your buyer may ask his professional team to thoroughly
evaluate your company. Tax experts, attorneys, accountants and bankers will all
scrutinize your company and provide an evaluation to the buyer from their own
perspective. Due diligence is an intense process that can surprise many
unprepared sellers. Armed with a well-prepared CBR, along with full proper and
defensible documentation, an experienced ACG intermediary will see you through
due diligence successfully. The questions asked by the buyer’s business
advisors will have been anticipated, ensuring that the deal remains intact and
momentum is maintained.
7. Definitive Agreement – Their understanding of own
professional advisors—attorneys, bankers and accountants of the goals and the
circumstances surrounding the M&A transaction will help speed the
development of a final Definitive Agreement. Distilling all prior discussions
and documentation down into a single agreement requires thoroughness and
attention to details. Once the agreement is written, it is imperative that
buyer, seller, and their effective advisors carefully review it, understand
their mutual obligations, and execute the agreement.
8. Closing and Transition to
New Ownership –
When the goals for the sale have been met and the buyer is satisfied with the
deal structure, the Definitive Purchase Agreement is signed. This facilitates
the transfer of company assets to the buyer. Throughout the first nine steps of
the business-sale process. Issues concerning the integration of the company,
corporate style and employees with the buyer’s style and employees have to be
fully analysed and resolved, anticipating the ownership transition.