Mergers and acquisitions have been popular business tools since the late 1800s. In 1920, MGM was formed when movie theater owner Marcus Lowe acquired Louis B. Mayer Pictures, Metro Pictures, and Goldwyn Pictures.
It cost Loew $8 or $108 million in today’s money.
In 2013, Verizon and Verizon Wireless merged together. That merger was worth $132 billion dollars.
Most people assume that a business merger and business acquisition are similar terms; however, they’re actually quite different. Keep reading to learn the difference between merger and acquisition.
What an Acquisition Is
When Marcus Loew purchased the three movie companies, he formed a new company, MGM. In other words, Loew purchased three businesses and kept everything the same, including the name, though it was now shortened to initials.
In this type of deal, the owner or purchasing companies were retained and absorbed into Loew’s original company.
Some Takeovers Are Not Friendly or Wanted
These types of takeovers are sometimes considered to be hostile or even involuntary if the company that is absorbed wasn’t willing to give up their independence.
In this case, the larger company has to purchase at over 50% of the other company’s stock to begin a hostile takeover. Otherwise, the company making the buy must come up with a large sum of cash in order to purchase a smaller business.
The Larger Company Is Completely in Charge
Once the smaller business is purchased, no new stock is issued.
That parent company is always the larger of the two companies. And after it has purchased the smaller company, it gets to make 100% of all company decisions.
However, due to the negative connotations that takeovers are associated with, many companies will claim they have in the process of merging with another company, even though it’s an inaccurate term.
Strategies for Successful Takeovers
There is more than one way to purchase another company such as:
Accelerating is a good strategy to use when a larger company purchases a smaller company and uses its best resources in order to speed up market access for the smaller company’s products.
Consolidating works when one company buys another company in order to remove their competition from an already over-supplied market.
A company would use this method if it wanted to gain access to what the smaller company has in terms of its:
- Intellectual property
- Market positioning
This method is often more cost-effective than it would be for the larger company to develop them on its own.
Speculating occurs when a larger company buys a smaller company that has developed a new product.
The aim is to take advantage of that product’s future growth and profit potential.
This is when a company purchases another company then makes necessary changes to increase productivity and profitability.
The parent company then sells the smaller company again for profit.
What a Merger Is
Unlike takeovers, mergers are always 100% agreed upon by all participating parties. Two companies come together to form an entirely new company.
There are several reasons why mergers take place such as to:
- Increase revenue
- Enter into new markets
- Increase competitive advantage
- Grow business
- Reduce costs
Sometimes all of the above reasons are why companies choose to merge together.
Mergers Can Happen With Businesses of Any Size
While it’s possible that larger companies choose to merge with smaller ones, sometimes companies of the same size merge as well. This is what’s known as a merger of equals.
A good example of a merger is when AOL (American Online) merged with Time Warner in 2000.
This merger was valued at $164.75 billion dollars.
Join Together to Work as One
Mergers allow both parties to work together as one company. They are always planned and always friendly.
A new name is given and new stock is issued with mergers.
How Mergers Can Be Structured
There are several different methods to structure a method such as:
This happens when two companies merge that share no common business areas. This happened when PayPal and eBay merged together.
When two businesses merge who serve the same customer base but in different ways. A good example is when Citigroup merged with Travelers Insurance.
These occur when two companies merge together who were in direct competition. They therefore already shame the same product lines and markets.
This happened when HP (Hewlett Packard) and Compaq merged together.
When two companies are selling the same products but in different markets merge together.
A good example is when banks merge together such as when Bancshares Inc merged with RBC Centura.
Vertical mergers happen between either a customer and a company or a supplier and a company.
A good example is when in 1996 when Time Warner Inc merged with Turner Corporation.
How Companies Are Valuated for Both Mergers and Acquisitions
Before a company can purchase or merge with another company, it’s vital to first understand how much value each company has. The following metrics are used to value each company.
Discounted Cash Flow
Discounted cash flow analysis helps determine a company’s current value. This is determined by its estimated future cash flows.
To get this number a company would use this method:
Forecasted free cash flows (net income + depreciation/amortization – capital expenditures – change in working capital). This number is then discounted to a present value using the company’s weighted average costs of capital (WACC).
Sometimes takeovers are based on the cost of what it would take to simply replace the company they are interested in purchasing.
This is used if a larger company wants to order the smaller company to sell at the price of the value of the sum of its equipment and staffing costs.
Enterprise-Value-to-Sales Ratio (EV/Sales)
EV/Sales ratios are used by the purchasing company to make an offer as a multiple of the revenues. However, they are also aware of the price-to-sales ratio of other companies within that same industry.
Used by the purchasing company to make an offer that is a multiple of the earnings of the company they want to buy. The acquiring company would examine all the P/E for all stocks within the same industry group.
This ratio provides them with a good idea of what the target company’s P/E multiple should be.
Get the Right Business Attorney on Your Side
No successful acquisition or merger happens without a business lawyer representing each side. And if you’re thinking of getting involved in either business method, you need to hire the right team.
We can help. We’re well-versed in M&A and we’re here to make sure you walk away from either one satisfied. Contact us and learn how we can help.