Mergers and acquisitions: how does it work?

Mergers and acquisitions

Mergers and acquisitions: The Outline

Mergers and acquisitions are now an integral part of business life. Whether it is to increase the external growth of the company or to resist competition, there are many reasons that justify the use of mergers and acquisitions.

If this operation can be a real success, it is also a perilous exercise which can sometimes lead the company to bankruptcy. It is therefore important to understand the ins and outs of mergers and acquisitions. We explain everything in this article!

Mergers and acquisitions: what is it?

Merger-acquisition (M&A), is an operation by which two or more companies come together to merge their assets and form a single one. The selling company transfers its assets to the buying company, which then takes legal control of the acquired company and holds the powers at general meetings. However, each company retains its legal individuality.

Companies use mergers and acquisitions to accelerate their growth, increase their market share, access new markets, diversify their activities and increase their financial strength. Mergers and acquisitions are an instrument of external growth.

The merger-acquisition operation is not a trivial financial transaction. It has economic, tax, legal, human consequences… It totally disrupts the life of the company.

Also note that M&A can be hostile or friendly.

What are the different types of mergers and acquisitions?

There are different types of mergers and acquisitions which are distinguished by the motives behind them. They are of 3 orders:

1. Vertical merger acquisition

the company takes control of another company in the production chain to which it belongs to increase its market share, reduce transaction costs and eliminate intermediaries. For example, a furniture factory buying a sawmill;

2. Horizontal merger acquisition

the company buys a company in the same sector of activity as it to strengthen its position on the market and eliminate competition;

3. Conglomerates

The company wishes to diversify its activities, it then acquires companies in various fields of activity. The main objective here is the diversification of the company.

What is the difference between a merger-acquisition and a merger-absorption?

If the merger-acquisition and the merger-absorption pursue more or less the same objective, the total or partial control of another company, their legal specificities differ.

The merger-absorption is an operation by which one or more companies, called the absorbed companies, transmit their assets to another company, called the absorbing company.

This operation is characterized by the absorption of one or more companies by another to form a single legal entity. The merger results in the dissolution without liquidation of the absorbed companies. Only the acquiring company retains its legal personality.

In the context of a merger-acquisition, there is indeed a transmission of assets from one company to another. However, the acquiring company does not absorb the selling company. The 2 legal entities remain, the buying company simply acquires legal control of the selling company.

What are the steps of the merger-acquisition process?

Mergers and acquisitions are complex and delicate operations that require compliance with a specific procedure. In addition, the process requires the intervention of a certain number of specialists such as a specialized consulting firm, a wealth management firm, an audit firm, investment bankers or even lawyers specialized in merger-acquisition.

The support of the company by professionals is essential to carry out a merger-acquisition project.

1. Preparation phase

The merger-acquisition begins with a preliminary stage during which a diagnosis of the project is developed and then an acquisition plan. The objective is to define the merger-acquisition project and to assess the possible risks.

You must:
  • Determine the needs of the acquiring company and its objectives: increase market share? Acquire new products or services? Eliminate the competition? This is an essential step in developing a strategy;
  • Evaluate the financial condition of the acquiring company: A careful analysis of accounts and liquidity is essential to determine if the company has sufficient resources to acquire another company. The transaction can be financed by cash outflow, the acquirer then finances the transaction by borrowing or with its own funds, or by purchasing or exchanging securities;
  • Identify your target: it is essential to choose the right company or companies with which to merge and to analyze their organization, structure, resources, etc.;
  • Analyze the market situation: is the current market favorable to this type of operation?
  • Once the diagnosis has been made, the acquisition plan should be built: define a strategy, designate the target, build a team, contact professionals…
2. Negotiation phase

The negotiation phase is the stage during which the buying company is in contact with its target. The parties discuss the operation (the future takeover), its organization, its financial conditions and its terms of payment. Whether the merger and acquisition is hostile or friendly, good communication between the companies is essential to the success of the operation.

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All information must be clearly exchanged to avoid possible disputes. It is important to be transparent. During this phase, diplomacy and professionalism are also required to avoid any discrepancy and convince the selling company to contract with your company.

3. Integration phase

The success of the merger-acquisition operation also depends on the conditions of integration of the new acquired entity. Indeed, this operation leads to profound upheavals within societies that must be anticipated so that integration takes place under the best conditions.

Culture, organization, processes can be completely different from one company to another. It is therefore essential to plan the transition, and possibly to create a team dedicated to this for optimal harmonization between companies.

What are the advantages of mergers and acquisitions?

If many companies resort to mergers and acquisitions, it is because its advantages are multiple. Indeed, the decision to bring together several companies can be justified by financial motivations or even by more strategic reasons such as reducing costs, limiting competition, opening up to the international market, etc.

1. Grow the company

Growing a company internally can take years. M&A is then the fastest way to increase the growth of your business. Indeed, the combination of the resources and skills of two or more companies results in accelerating the development of the acquiring company.

Mergers and acquisitions are particularly interesting for small companies whose limited resources can slow down their development. By uniting with other companies, they can improve performance, increase their market share, and stimulate their growth.

2. Economy of scale

By grouping two or more companies, purchasing volumes are greater so that companies can benefit from cost reductions. In addition, this combination of companies results in cost sharing since the production tools are no longer purchased twice.

Saving money is also one of the objectives of vertical mergers and acquisitions, the purpose of which is to buy out the intermediaries in the production chain (suppliers, distributors, etc.) and thus reduce costs.

3. Diversification

Mergers and acquisitions are also an excellent strategy for diversifying a company’s activities. This is particularly the purpose of conglomerates. By buying one or more companies from different sectors, the acquiring company can integrate new activities within it and thus penetrate new markets on which it did not have enough credibility to sell before.

In addition, the company acquires new skills and knowledge which can result in increasing its competitiveness and expanding its presence in the market.

4. Limit competition

Reducing competition and establishing yourself as a market leader are among the advantages of mergers and acquisitions. Indeed, by uniting with other companies in the same sector, the purchasing company can gain market share and dethrone the company that is positioned in first place in the market.

In addition, the absorption of competing companies reduces price competition. Limiting competition is one of the objectives of horizontal mergers and acquisitions.

5. Penetrate the international market

Mergers and acquisitions are a relevant solution for penetrating the international market, which is otherwise inaccessible to it. Indeed, buying foreign companies can be a way to enter a new larger market.

This is also the strategy adopted by the operator Orange, by acquiring T-Mobile UK, to penetrate the British market.

6. Tax benefits, fiscal

Finally, by buying out a competing company, the acquiring company is liable for a lower tax on profits.

Mergers and acquisitions: failures

If a merger-acquisition operation can be motivated by legitimate reasons, it is a perilous exercise and the results are not always up to expectations and they can even endanger the company.

Indeed, the development of a relevant strategy, the planning of the integration and the determination of the price of the operation are steps that should not be neglected.

The operation can be destructive if the price paid was too high, or if the integration of the companies was not properly carried out.

Sources: PinterPandai, Investopedia, Street of Walls

Photo credit: Geralt via Pixabay

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