There are a number of different types of mergers and acquisitions, including vertical, horizontal, congeneric, market-extension, product-extension, and conglomerate.
The benefits of each are varied, and depending on your strategy could include:
- building economies of scale
- increasing market share
- decreasing competition
- boosting efficiencies
- expanding product lines
- diversifying offerings
There are also, however, negative connotations associated with each type, which should also be carefully considered before merging companies.
Understanding which type of merger or acquisition will best support your long term strategy requires a careful look at the pros and cons of each type, and the support of an expert advisor for guidance.
In an M&A transaction, the valuation process is conducted by the acquirer, as well as the target. The acquirer will want to purchase the target at the lowest price, while the target will want the highest price.
Types of M&A by transactions
The following are some common transactions that fall under the M&A umbrella:
In a merger, the boards of directors for two companies approve the combination and seek shareholders’ approval.
In a simple acquisition, the acquiring company obtains the majority stake in the acquired firm, which does not change its name or alter its organizational structure.
Consolidation creates a new company by combining core businesses and abandoning the old corporate structures. Stockholders of both companies must approve the consolidation, and subsequent to the approval, receive common equity shares in the new firm.
Acquisition of Assets
In an acquisition of assets, one company directly acquires the assets of another company. The company whose assets are being acquired must obtain approval from its shareholders. The purchase of assets is typical during bankruptcy proceedings, wherein other companies bid for various assets of the bankrupt company, which is liquidated upon the final transfer of assets to the acquiring firms.
In a management acquisition, also known as a management-led buyout (MBO), a company’s executives purchase a controlling stake in another company, taking it private. These former executives often partner with a financier or former corporate officers in an effort to help fund a transaction. Such M&A transactions are typically financed disproportionately with debt, and the majority of shareholders must approve it.
In a tender offer, one company offers to purchase the outstanding stock of the other firm at a specific price rather than the market price. The acquiring company communicates the offer directly to the other company’s shareholders, bypassing the management and board of directors.
To create a great deal structure, aim for a win-win scenario, where the interests of both parties are well represented in the deal and risks are reduced to the barest minimum.
Most often, win-win deal structures are more likely to lead to a sealed merger or acquisition deal and may even reduce the time required to complete the M&A process.
The most difference between a M&A – a merger and an acquisition relates to the size of the companies involved. In an ‘unfriendly’ deal (or hostile takeover), a target company does not wish to be purchased, but may do so out of necessity. In these instances, it is always considered an acquisition.
There are two important documents that are used to delineate the M&A deal structuring process. They are the Term Sheet and Letter of Intent (LOI).
- Term Sheet: A Term Sheet is a document stating the terms and conditions of an intended financial investment, in this case, a merger or acquisition. Term sheets generally are legally binding unless otherwise stated by the parties involved.
- Letter of Intent (LOI): As the name implies, a Letter of Intent (LOI) is a document outlining the understanding between two or more parties that they intend to formalize later in a legally binding agreement. Like the term sheet, an LOI is usually not intended to be legally binding except for the binding provisions included in the document.
Types of M&A by integration
Horizontal integration and vertical integration are competitive strategies that companies use to consolidate their position among competitors.
Horizontal integration is the acquisition of a related business. A company that opts for horizontal integration will take over another company that operates at the same level of the value chain in an industry.
A horizontal merger occurs when two companies operating in the same market (and selling similar products or services) come together to dominate market share.
This type is attractive for merging companies aiming to build economies of scale and decrease market competition. However, there are potential downsides. A horizontal merger comes with increased regulatory scrutiny and stringency, and can lead to a loss of value if the post-merger integration is not fully realized. Regulatory due diligence should be executed with extra special care. An example of a horizontal merger might be if McDonald’s and Burger King joined forces.
Vertical integration refers to the process of acquiring business operations within the same production vertical. A company that opts for vertical integration takes complete control over one or more stages in the production or distribution of a product.
Vertical mergers involve two companies in the same industry who operate in different stages of production.
This could involve a retailer who merges with a wholesaler, or a wholesaler merging with a manufacturer, for example. This type of merger is ideal for streamlining operations, boosting efficiencies, and cutting costs across the supply chain, but it can also reduce flexibility and result in new complexities for the business to manage.
Two businesses that serve the same consumer base in different ways, such as a TV manufacturer and a cable company.
In a congeneric merger, the acquirer and target company have different products or services, but operate within the same market and sell to the same customers.
They could be indirect competitors, although their products often complement each other. As these companies already share similar distribution channels, production or technology, this type of merger can allow the new business entity to expand its product lines and increase market share. As a downside, the fact that these two companies already operate within the same industry could limit further diversification.
A market extension merger describes two companies in the same industry who join forces with the aim of expanding market reach. Commonly, this type of transaction occurs across multiple geographic regions. A product extension merger occurs when a specific product is added to the product line of the acquirer from the acquired company.
Two companies selling different but related products in the same market. Conglomeration:Two companies that have no common business areas.
Mergers and acquisitions involve the coming together (synergizing) of two business entities to become one for economic, social, or other reasons. A merger or acquisition is possible only when there is a mutual agreement between both parties. The agreed upon terms on which these entities are willing to come together are known as an M&A deal structure.
Ways of Structuring an M&A Deal
There are three well-known traditional ways of structuring a merger acquisition deal although, in recent times, business entities have engaged in other, more creative and flexible deal structuring methods. The three traditional ways of structuring an M&A deal are asset acquisition, stock purchase, and mergers. The methods can also be combined to achieve a more flexible deal structure.
In an asset acquisition, the buyer purchases the assets of the selling company. An asset acquisition is usually the best deal structure for the selling company if it prefers a cash transaction. The buyer chooses which assets it wants to purchase.
Advantages of an asset acquisition may include:
- The buyer can decide which assets to buy from the seller and which not to.
- The selling company continues as a corporate entity after the sale, containing the remaining unsold assets and liabilities.
Disadvantages of an asset acquisition include:
- The buyer may not be able to acquire non-transferable assets, e.g., goodwill.
- An asset acquisition may lead to high-impact tax costs for both the seller and the buyer.
- It may also take more time to close the deal, compared to other deal structures.
Unlike an asset acquisition, where there is a direct transaction of assets, assets are not directly transacted in a stock purchase. In a stock purchase acquisition, a majority amount of the seller’s voting stock shares are acquired by the buyer. In essence, it means control of the seller’s assets and liabilities are transferred to the buyer.
Advantages of a stock purchase acquisition:
- Taxes on a stock purchase deal are minimized, especially for the seller.
- Closing a stock purchase deal is less time-consuming since negotiations are less complicated.
- It may be less expensive.
Disadvantages of a stock purchase acquisition:
- Legal or financial liabilities may accompany a stock purchase acquisition.
- Uncooperative minority shareholders may also be a problem.
Though the term “merger” is commonly used interchangeably with “acquisition,” in a strict sense, a merger is the result of an agreement between two separate business entities to come together as one new entity. A merger is typically less complicated than an acquisition because all liabilities, assets, etc. become that of the new entity.
In structuring a deal, the advantages and disadvantages must be considered along with other influencing factors to reach a conclusion on which method to adopt.
Edited by Tetiana Mykhailova — CFO Beinsure / Commercial Director Finance Media