Mergers and Acquisitions (M&A) are increasingly becoming a novel approach for companies to wade through the competitive pressures of today’s globalized society. The increase of mega-mergers in today’s corporate world demonstrates the entrenchment of such transactions in modern business practices.
Definitions of Mergers and Acquisitions
“One plus one equals three”. This statement defines the main logic that informs merger and acquisition transactions. This logic stems from the fact that most companies aim to create a bigger shareholder value than the sum of the shareholder value that would ordinarily be realized if two corporate entities merge. The reasoning behind merger and acquisition transactions therefore stems from the fact that there is a greater value when two companies work together, as opposed to two companies working in isolation. Mergers and Acquisitions (M&A) are therefore joint activities where the activities of two or more companies merge to create one common purpose for both companies.
The purpose of engaging in mergers and acquisitions, as two different business processes, has increasingly become unclear for most businesses. The ambiguities regarding the purpose of both transactions come from the fact that both mergers and acquisitions pursue one ultimate economic outcome – increased profitability. Despite the commonality of purpose, mergers and acquisitions have slightly different meanings, based on their modes of finance.
Mergers normally occur when two companies (usually of equal size) decide to merge their operations. This type of merger is called a merger of equal value; however, such mergers are often rare because, ordinarily, most companies do not have equal value. Instead, one company will purchase another by merely requiring it to state that it is a merger of equal size (although this may not be the case). Companies prefer to call such hostile takeovers “mergers,” to sound politically correct, because buying out other companies often bears negative connotations. Concisely, companies often try to disassociate themselves from these negative connotations to make the “buyout” more acceptable to all the parties involved. Therefore, the correct term to refer to such a transaction is an acquisition.
However, the difference between Mergers and Acquisitions (M&A) does not only rest in semantics. The modes of agreement between the two or more companies that will merge mainly define the distinction between mergers and acquisitions. Acquisitions differ from mergers because they are often agreeable, unlike mergers where the parties may not be completely conformable with the deal. Sometimes, in mergers, two parties may merge merely because of convenience, or because they have no other alternative, but to do so.
Legally the difference between Mergers and Acquisitions (M&A) manifests when one party seizes to exist and another party establishes itself as the new legal entity (this is commonly true for acquisitions). However, for mergers, two companies may decide to conduct businesses as one legal entity, instead of conducting their businesses as two entities. Here, both companies may decide to surrender their stocks and issue new stocks that symbolize the merger between the two companies. Therefore, the legal differences between a merger and acquisition stem from the fact that merging companies may retain some unique operational distinctions, as opposed to acquisitions that completely dissolve the distinctions between the parties. A common example of a merger is the merger between Daimler-Benz and Chrysler. In the merger, both entities were legally seized to exist and a new company, DaimlerChrysler, emerged. Comprehensively, regardless of the nature of the association between two or more companies, the nature of their association mainly defines if the association is a merger or an acquisition. If the association is friendly, then people should regard it as a merger; however, if the association is hostile, people should conceive the association as an acquisition.
Classification of Mergers and Acquisitions
The classification of mergers and acquisitions depends on the nature of the industry and the types of players in the industry.
Types of Mergers
There are different types of mergers, including horizontal mergers, vertical mergers, and conglomerate mergers.
- Horizontal Mergers – Horizontal mergers normally occur when two or more companies that produce similar products merge. Ordinarily, such companies compete against one another and produce similar (or almost similar) products and services. Horizontal mergers are often common in industries where there are only a few players. This type of industry is characterized by intense competition. Therefore, the potential gains of market share in such industries tend to be greater for participating firms. The main motivating factor for companies to pursue a horizontal merger is to create more economies of scale. Again, the merger between Daimler-Benz and Chrysler is an example of a horizontal merger. Horizontal mergers are often criticized for their ability to reduce competition. This outcome often manifests because the number of potential rivals in the industry declines significantly if two or more mergers occur in an oligopolistic market. Even though the creation of anti-competitive effects may be true, horizontal mergers do not necessarily have a bad effect on the economy. For example, horizontal mergers decrease average costs of operations and increases the market power of companies in the industry (especially those that have merged). Nonetheless, market power and cost savings are not easy to determine. Similarly, market power and cost savings are often not typical for most mergers.
- Vertical Mergers – Vertical mergers normally occur when different companies in a production chain merge their activities to make the production process more efficient. There are numerous examples of vertical mergers. Among the oldest and most common examples of a vertical merger is the merger between Carnegie Steel Company merger and several associate companies to control the entire chain of its production process. The vertical merger allowed the Carneige Steel Company to control the steel production mills, the extraction of the iron ore process, the supply of coal, the transportation of iron ore, and the coal “cooking” process. Furthermore, through the same vertical merger objective, the Carneige Steel Company started to develop its internal talent as opposed to searching for the same talent outside the company.
- Conglomerate Mergers – Unlike horizontal mergers, conglomerate mergers normally occur when two or more firms, operating in different industries, merge. A classic example of a conglomerate merger occurred in the early sixties when a telecommunications company, ITT, diversified its operations by merging with Bought Hartford Fire Insurance, Continental Baking, Sheraton Hotels, Avis Rent-A-Car, Canteen vending machines, and 100 more companies. Some people consider conglomerate mergers to be important types of mergers because they increase managerial efficiencies. This outcome often suffices because the failure to increase managerial efficiencies may result in hostile takeovers or the replacement of inefficient managers with efficient managers.
Types of Acquisitions
The main types of acquisitions are asset acquisitions and stock acquisitions.
- Asset Acquisition – In an asset acquisition, one company normally sells strategic assets to the acquiring company. Such an asset acquisition process occurs when the acquiring company prefers to choose specific assets of a company and shuns other assets that it does not want responsibility for. The types of assets to be acquired may include tangible assets, such as office furniture, and intangible assets, such as goodwill. It is often difficult to transfer these assets because of the difficulties in valuation, the payment of transfer taxes, or the involvement of interested parties (especially in government contracts).
- Stock Acquisitions – Stock acquisitions involve the transfer of stocks of the selling company to the acquiring company. Unlike asset acquisitions, stock acquisitions are not difficult to execute because stocks are often transferable based on their current values. As such, there is no tedious process of valuing the assets. In addition, unlike the asset acquisition process, the seller does not receive any asset step-up tax; instead, the seller incurs the tax on a carryover basis (usually the goodwill created from a stock acquisition is not tax-deductible).
Merger and Acquisition Process
The process of completing a merger or acquisition is often a significant undertaking for any company. Therefore, it is usually important for companies to ensure that the process of merging or acquiring a new company is flawless. However, this task is usually very intimidating for most companies, but fortunately; the process is a detailed step-by-step undertaking.
Many EXPERTS have used several M&A models to explain the M&A process. For example, the Watson Wyatt Deal Flow Model contains a five-step model that has been used to explain most M&A processes. The model involves the analysis of the different stages that occur in the same horizon, but have a strong goal of ensuring there are correct and timely inputs into the entire M&A process. These stages are explained below;
- Step 1: When companies intend to make M&A transactions, they consult advisory firms to guide them through the entire process. The main role of these advisory firms is advisory. It is through this role that the advisory firms establish the main vision of the company, its goals, and how the company may attain these goals through strategic foresight. The advisory firms, therefore, provide the clients with a strategic foresight to show the M&A process flow and how this flow helps the company to achieve its goals. Occasionally, some companies may decide to sign the consultancy contract before the advisory firm provides them with a clear strategic forecast of the M&A transaction, but often most companies prefer to see this forecast to evaluate their needs, viz-a-viz what the company offers, to determine if they should sign the contract, or not.
- Step Two: The evaluation process is the second step of Watson Wyatt’s Deal Flow Model. The evaluation process involves the evaluation of the companies involved in the merger or acquisition process, based on their assets, liabilities, or equity, to establish how the optimum value of the company may be realized. Taxation and legal matters of the deal may be explored at this stage. The wishes of the companies involved in the merger, and the nature of the intelligence gathered during the evaluation stage, often forms the premise for understanding how the execution of the merger will occur.
- Step Three: The execution stage outlines the third step of Watson Wyatt’s Deal Flow Model. The execution stage is often very important for merger and acquisition transactions because advisory firms recommend the course of action to take during a merger or acquisition at this stage. For example, an advisory firm may recommend that a company should sell its equity to the public, or to another company at this stage.
- Step Four: The harvest stage outlines the fourth step of Watson Wyatt’s Deal Flow Model. The role of the advisory firm is often complete once a company sells to the public or the merger deal is complete. However, some advisory firms may participate in the integration process to ensure that the full implementation of the details of the merger. Regardless of the situation, the completion of a merger is a learning lesson for advisory firms. Indeed, by knowing all the details surrounding a merger or acquisition, the firm may refer to these details for the execution of future contracts.
Besides the outline of Watson Wyatt’s Deal Flow Model, Snow (2013) outlines a different set of steps that different companies should follow in the M&A process. He says that the first step in any merger or acquisition process is the identification of a suitable buyer or seller. The second step of the process is contacting the seller about the deal. This process is often crucial for the future of the deal because, at this point, it is easy to determine the level of interest for the seller or the buyer. This way, it can be equally easy to establish if proceeding with the process is feasible, or not. Pitching the right deal for a seller or a buyer is often a difficult process, especially for the buyer. The third step of the M&A process involves receiving or sending a teaser (executive summary) of the entire deal. This teaser provides the customer with just enough information to capture the interest of the buyer or the seller. The aim of the teaser is to make the seller, or the buyer, want to learn more. Later, both parties should sign a confidentiality document to affirm that the contents of their discussions will be confidential. Both parties should also review the confidential information memorandum (CIM) that discloses important information about a company (such as the products, financials, and history of the company). The aim of this process is to pre-empt an offer. After making an offer, either the seller or the buyer should make the offer with a specified range of valuation, as opposed to a specific price. After comparing the compatibility of the intentions of the seller and the buyer, based on the contents of the CIM, the seller or buyer should submit a letter of intent. Usually, the seller or buyer quotes a fixed price in this letter. Depending on the addressee of the letter, the seller/buyer should conduct due diligence to ensure that all the information provided in the agreement is accurate. After confirming the details of the agreement, both parties should draft the purchase agreement and sign it. The acquisition or merger is thereby completed and the seller/buyer evaluates how the new entity fits into the existing business model.