M&A Deep Dive: Acquisitions
In 2021, the total of mergers and acquisitions (M&A) deals announced as of August 2021 amounted to $3.6 trillion-of which the U.S. alone accounted for $2.14 trillion-surpassing $3.59 trillion in all of 2020, per the Refinitiv data. Considering the enormous volume of such transactions, it is unfortunate that many business owners consider mergers and acquisitions to be the same and use them interchangeably.
Mergers differ from acquisitions and refer to different types of transactions. While we hear about M&A deals of large, well-known companies, they occur more regularly between small and medium-sized companies. So, as a business owner, you should know about mergers and acquisitions.
What Is M&A?
Mergers and acquisitions both represent the consolidation of companies or assets via different financial transactions, including management acquisitions, mergers, asset purchases, etc.
Mergers are financial transactions wherein two companies combine voluntarily, broadly on equal terms, to become a new legal entity under one name. They do so to expand reach, gain market share, acquire new territories, reduce costs, grow revenues, expand into new segments, and increase profits.
For example, Exxon and Mobil (The first and second-largest oil producers in the U.S.) merged in 1999 for $80 billion to enhance their global competitive ability. Since then, their shares have gone up 293 percent, and dividends have been reinvested.
When a company purchases the majority of another company’s shares or assets to gain control of that company, it is an acquisition. If the purchasing company acquires over 50 percent of the target company’s shares or assets, it can make decisions without the approval of the target company’s shareholders. However, the two companies operate separately.
Companies usually acquire target companies to enter a new market, increase market share, seek economies of scale, diversify, reduce costs, increase synergies, etc.
For example, Facebook acquired WhatsApp in 2014 for $19 billion. With this deal, WhatsApp provides the potential for Facebook to bring more businesses (thousands each day) into its advertising program.
As mentioned earlier, an acquisition is a financial transaction where one company purchases a majority or complete stake in another company. Both companies continue to exist as separate legal entities. The purchasing company becomes the parent company of the target company.
Types of Acquisitions
Depending on the business expansion strategy based on a product line, business activities, or industry, acquisitions are categorized as:
- Horizontal acquisition
- Vertical acquisition
- Conglomerate acquisition
- Congeneric acquisition.
One company acquiring another in the same business line is a horizontal acquisition. The target company may be a competitor working at the same production stage. This type of acquisition helps the parent company improve its competitive position and increase market share. For example: When an energy-producing company purchases a competing company, it is a horizontal acquisition.
A vertical acquisition is when one company acquires another owned by its suppliers, distributors, manufacturers, or retail locations to streamline its operations. Here, rather than outsourcing various stages of the production process, the parent company takes direct ownership. For example, a vertical acquisition is a manufacturing company purchasing a cotton farm (the source of raw material cotton) to increase control over the supply chain.
A conglomerate acquisition is when one company acquires another engaged in unrelated business activities. The target company may be from a different industry, deal in different products and services, or different geographical areas. With this acquisition, the parent company enters a new market, sector, or location. For example, a soft drink company acquiring a garment business is a conglomerate acquisition.
A congeneric acquisition involves acquiring another company that shares similar technology, distribution lines, etc. However, the production activities of both companies are not related, or they offer different products within the same or related industry. This type of acquisition helps the parent company quickly expand its product lines and market share. The overlap of technology or production systems between the two companies creates synergy. For example, when a company selling printers for home offices acquires another company producing printer ink to increase its product line offering to existing customers who buy both products, it is a congeneric acquisition.
A company acquires another to take control of the target company, build on its strengths, and capture synergies such as cost savings, revenue increase, etc. Common reasons for acquisitions include higher market share, economies of scale, new niche offerings, etc. Other reasons why companies acquire other companies are:
To acquire technologies or skills. Instead of spending time, money, and effort developing new technology, acquiring another company already using the technology successfully may be the easier, quicker, and most cost-effective option.
To enter a new geographical area. Crossing geographical boundaries may be challenging, especially when establishing a business in a foreign country. Different laws apply. Acquiring a functional business already operating in that location eases expansion into that market.
To remove excess capacity. Sometimes, there is too much supply or competition. Companies can eliminate the competition and reduce excess capacity by acquiring the most productive providers.
Benefits/Pros of Acquisitions
Fresh perspectives and ideas from experts. Acquisitions help companies get fresh perspectives and ideas from a new team of experts. The target company receives guidance from specialized experts in the larger parent company.
Improved access to capital. After the acquisition, small target companies enjoy increased funding for business growth. Business owners need not invest their personal funds.
Increase in market power. An acquisition enables the purchasing company to gain market share quickly, reduce competition, achieve market synergies, and ultimately enlarge its power in the market.
Fill critical service gaps. The ever-evolving marketplace and changing situations create service gaps that companies can fill by acquiring other companies to serve their clients without interruption.
Opportunity to create leverage. The acquisition strategy creates leverage by helping to balance revenues and cut costs by eliminating overlaps and increasing the buying and negotiating power of the company within the supply chain.
Allows for an evolving business model. Acquiring a new business model is cheaper than developing one from the ground up. So, purchasing companies can transition from their current business model quickly.
Challenges/Cons of Acquisitions
Clashing corporate cultures. Many departments may face problems due to a post-acquisition clash of cultures. Even if companies go into the acquisition process with clear expectations, some rogue elements dissatisfied with current events may create trouble.
Conflicting objectives and goals. Both companies operate independently before the acquisition, so there may be conflicts in direction and goals. For instance, the purchasing company may want to enter new markets, whereas the acquired company may be more interested in cost-cutting.
Brand damage. An acquisition could lead to confusion in the marketplace. For instance, if a powerful regional brand acquires a weak brand in another region to enter the new geographical area and promotes itself in the new market by using the weak brand’s equity, the strength of the parent company’s original brand eventually suffers.
Confusion in the marketplace. When a company pursues acquisition outside its industry, marketplaces confusion may result. For example, General Electric, at one time, made appliances and owned a bank, Universal Studios, and NBC.
Distraction in top management. Executive management is usually involved in the acquisition strategy and its responsibilities; however, those responsibilities may impede their attention to internal teams or cause them to ignore internal needs. That may harm production levels and profitability.
Internal fallout. An acquisition strategy may threaten the security of employees and require managers to take up new, unfamiliar duties, products, or services. This uncertainty may lead to internal fallout, quickly turning a healthy company into an unhealthy one.
Acquisitions are a common form of business exit and strategy, offering both benefits and challenges. Expert advisors can help you pick the right business and exit strategies for your unique company. Value Scout can help you connect with experienced and top advisors.
Get in touch to learn more.