Mergers and acquisitions (M&A) are agreements that include the joining of two businesses in some way. Despite being used interchangeably, mergers and acquisitions (M&A) have distinct legal definitions. In a merger, two businesses of comparable size come together to form a single new entity.
On the other hand, an acquisition is when a larger company acquires a smaller company, thereby absorbing the business of the smaller company. M&A deals can be friendly or hostile, depending on the approval of the target company’s board.
Mergers and Acquisitions (M&A) Transactions – Types
1. Horizontal - A horizontal merger takes place between two businesses that function in related fields but may or may not be direct rivals.
2. Vertical - Along the supply chain, a vertical merger happens between a business and a supplier or customer. The corporation seeks to ascend or descend the supply chain in order to strengthen its position within the market.
3. Conglomerate - This kind of deal is typically made between businesses in unrelated industries and is done for diversification purposes.
Mergers and Acquisitions (M&A) – Forms of Integration
1. Statutory - Statutory mergers typically take place when the acquirer, who is significantly larger than the target, purchases both the assets and liabilities of the latter. The target company no longer exists as a separate entity following the purchase.
2. Subsidiary - In a subsidiary merger, the target keeps running its business while becoming a subsidiary of the acquirer.
3. Consolidation - When two businesses merge, they stop existing following the merger, and a brand-new company is created.
Reasons for Mergers and Acquisitions (M&A) Activity
Mergers and acquisitions (M&A) can take place for various reasons, such as:
1. Unlocking synergies - The primary goal of mergers and acquisitions (M&A) is to maximise synergies so that the merged business is more valuable than the two separate businesses. Synergies may result from lower costs or higher sales.
3. Stronger market power - A horizontal merger will give the new organisation a larger market share and the ability to control prices. Vertical mergers also increase a company's market power because they provide it more control over its supply chain and help it avoid supply shocks from outside sources.
4. Diversification - Businesses in cyclical industries feel compelled to diversify their cash flows in order to minimise losses when their sector experiences a downturn. A business can diversify and lower its market risk by acquiring a target in a non-cyclical industry.
5. Tax benefits - When one business generates a sizable amount of taxable income and another experiences tax loss carryforwards, tax benefits are examined. The acquirer can use the tax losses to reduce its tax obligation by purchasing the business with the tax losses. Mergers, however, are not typically carried out only for tax purposes.
Forms of Acquisition
There are two basic forms of mergers and acquisitions (M&A):
1. Stock purchase
In a stock purchase, the acquirer exchanges shares of the target company for cash and/or stock from the target firm's stockholders. In this case, the shareholders of the target, not the target, receive compensation. When buying stocks, there are a few things to keep in mind:
- All of the target's assets and obligations, even those that are not shown on the balance sheet, are taken on by the acquirer.
- The shareholders of the target must unanimously accept the transaction for the acquirer to be paid, which can be a drawn-out procedure.
- As they receive their reward directly, shareholders are responsible for paying the taxes.
2. Asset purchase
In an asset acquisition, the acquirer pays the target directly after purchasing the target's assets. When purchasing an asset, a number of factors should be taken into account, including:
- The acquirer won't take on any of the target's liabilities because it only buys the assets.
- Unless the assets are considerable, no shareholder approval is often needed because the payment is given straight to the target (e.g., greater than 50 percent of the company).
- The compensation is taxed as capital gains by the target at the corporate level.
Method of payment
1. Stock - In a stock offering, the buyer issues fresh shares and pays the target's shareholders with them. Based on an exchange ratio that is decided in advance owing to stock price variations, the number of shares received is determined.
2. Cash - An acquirer merely exchanges cash for the target's shares in a cash offer.
Mergers and Acquisitions (M&A) – Valuation
In a merger and acquisition, both the acquirer and the target participate in the appraisal process. The target will demand the greatest price, whilst the acquirer will prefer to pay the least for it.
Because it helps the buyer and seller determine the final transaction price, valuation is a crucial component of mergers and acquisitions (M&A). The target is valued using the three main approaches listed below:
Discounted cash flow (DCF) method - Based on the target's projected cash flows, a value is determined.
Comparable company analysis - The target's worth is determined using relative valuation criteria for public enterprises.
Comparable transaction analysis - The target's worth is determined using valuation parameters for prior comparable transactions in the sector.