Understanding the Fundamentals of Mergers and Acquisitions

Mergers and acquisitions are strategic business activities to meet objectives on growth, an increase in market presence, and diversification in portfolios. Companies apply M&A for various reasons, such as the achievement of competitive advantage, entrance into new markets, or exploiting synergies. However, transactions related to M&A demand all-around knowledge, from legal to financial and even operational knowledge, to facilitate transactions easily. The primary frameworks of M&A transactions are outlined below.

What is Merger and Acquisition?

Mergers and acquisitions, or M&A, are deals in which two companies merge, either through operation or through the acquisition of one company by another. The two terms are often synonymous, but mergers and acquisitions have different legal, operational, and financial processes.

  • Merger: This situation occurs when two firms of comparative size and strength join together and form a new firm. The original firms’ identities usually dissolve into a new organization, but management and operational aspects are combined.
  • Acquisition: Here, one company acquires another firm, bringing all of its operations under one roof. The acquired firm may continue either to operate as a subsidiary of the acquiring firm or be absorbed wholly, and its operations ultimately merge with those of the acquirer.

Objectives of M&A Transactions

Companies pursue M&A transactions for a variety of reasons, including:

  1. Growth and expansion: The M&A environment enables companies to quickly explore new markets or regions by acquiring established businesses.
  2. Synergies: In every deal, the two companies merge to explore their strengths, create operational efficiencies, save on costs, and increase profitability.
  3. Market Power: This business might increase its market share while its competition might reduce when it merges with or acquires a competitor.
  4. Diversification: Buying companies in diversified industries will help derive diversified revenue streams to mitigate the impact of a negative one market.

M&A activities involve highly complex legal and financial formalities, so professionals must be well grounded in the subjects covered under corporate law courses concerning the said transactions.

M&A Transaction Types

There are distinct types of M&A transactions, each serving distinct strategic purposes. Knowing the different types can help companies decide which one best achieves their specific business goals.

Types of Merger

  1. Horizontal Merger: Here, the two firms belong to the same industry and are at the same production level. In a horizontal merger, competing companies in the field of telecommunications may merge with each other to dominate the market and reduce competition. Horizontal mergers are associated with high market power, but generally, they are watched strictly by regulatory authorities like the Competition Commission of India (CCI) so that a monopoly can not be created.
  2. Vertical Mergers occur between firms operating at different levels along the supply chain of the same industry. For example, a car manufacturer’s merger with a parts supplier would be referred to as a vertical merger. Mergers enhance the efficiency of operations and lower costs by acquiring greater control over the supply chain.
  3. Conglomerate Merger: Here, the products and services being pooled are from diverse industries that are altogether different. The main purpose is to increase the scope of business with various sectors. For example, if an electronics company and a firm dealing with food processing join together, it would be regarded as a conglomerate merger. The businesses may not have synergies in operations, but diversification allows financial benefits in the form of risk distribution across different markets.

Types of Acquisitions

  1. Asset Acquisition: In this type of deal, a company acquires specific assets belonging to another company without acquiring that particular entity. These could include land, machinery, patents, or any other intangible and tangible assets. The purchasing company buys specific resources without the liabilities of an entire company.
  2. Stock Acquisition: In a stock acquisition, the buyer corporation acquires an influential share of control over the target corporation by purchasing outstanding shares. The old management and operational structures may remain as such or may be merged into the acquiring corporation in a stock acquisition.
  3. Management Buyout (MBO): An MBO is the buyout of a company by its existing management team. In most cases, the incumbent management team acquires the company with external financing. MBOs are normally chosen when the management is very bullish about the company’s future prospects, but others, such as external investors or shareholders, will not.

M&A Form Integration

Amongst the most critical stages of any M&A transaction is the post-merger integration process through which merging firms combine their operations, employees, and resources. Integration can make or break a merger’s success. Lack of proper integration will undoubtedly contribute to inefficiency in operations, loss of crucial people, and failure to achieve expected synergies.

Types of M&A Integration

  1. Full Integration: Full integration is full absorption. In this type of integration, all operations, systems, and employees of the target company get fully integrated into the acquiring entity, and the target company’s brand may no longer exist. This type of integration happens in acquisitions where the acquirer seeks to acquire a competitor, eliminate competition, or streamline operations.
  2. Partial Integration: In partial integration, the acquiring company integrates only a part of the target company’s operations, leaving other operations free. This strategy is useful in preserving certain capabilities or brands of the target company while requiring integrating major operations.
  3. Holding Company integration: With this model, the acquiring firm acquires ownership of the target firm but enables the latter to continue operating its business under the same management that initially operated it. The acquiring firm becomes a holding company, controlling the strategic and financial decisions of the business; however, the target firm retains autonomy in its business operations.

Types of Valuation

Valuation of the target firm is the most critical aspect of an M&A transaction. In most cases, valuation determines the target firm’s fair market value and is used as a basis for negotiation by both the buyer and seller. Several methods of valuation exist, depending on the industries and the size and financial status of the companies.

  1. Discounted Cash Flow (DCF) Analysis: This measures a firm’s value based on its projected future cash flows, which are discounted to their present value using a discount rate. Consequently, the DCF method is very effective for use in companies with predictable and stable cash flows, which are closer to the company’s earning power in the future.
  2. Comparable Company Analysis (CCA): CCA estimates the value of a target firm based on comparison with similar firms in the same industry that recently sold or are publicly traded. The target company is fairly compared with similar companies through financial ratios, which include Price-to-Earnings (P/E) or Enterprise Value to EBITDA (EV/EBITDA). It gives an external market-based approach for evaluating the value.
  3. Precedent transactions: This approach will refer to past deals in a similar business in recent times to calculate the target company’s fair value. Precursor transactions are applicable in the market-going rate determination for similar businesses but may depend on the market factors present at the time of the previous deal.
  4. Asset-Based Valuation: An asset-based valuation will take the total value of the assets and subtract the liabilities from it. In cases where tangible values are higher, the most common industries for this would be those that are heavy in assets, like manufacturing or real estate.

Professionals processing M&A transactions should be able to show an advance in knowledge of valuation methods, which can be achieved through law certification courses focusing on the financial and legal aspects of mergers and acquisitions.

Conclusion

Merger and acquisition activities are among the most essential strategies companies engage in as they pursue growth, diversification, or market domination. However, the success of any M&A transaction largely depends upon the proper understanding of the legal, financial, and operational processes accompanying the merger. From the right choice of the type of transaction and the appropriate integration method to the proper valuation of the target company, every step requires careful planning and execution. Hence, the only way companies can realize strategic objectives and obtain long-term value through M&A transactions is through effective management of these processes.