Mergers and acquisitions

Mergers and Acquisitions

A merger occurs when one firm assumes all the assets and all the liabilities of another. The acquiring firm retains its identity, while the acquired firm ceases to exist. A majority vote of shareholders is generally required to approve a merger. A merger is just one type of acquisition. One company can acquire another in several other ways, including purchasing some or all of the company's assets or buying up its outstanding shares of stock.

In general, mergers and other types of acquisitions are performed in the hopes of realizing an economic gain. For such a transaction to be justified, the two firms involved must be worth more together than they were apart. Some of the potential advantages of mergers and acquisitions include achieving economies of scale, combining complementary resources, garnering tax advantages, and eliminating inefficiencies. Other reasons for considering growth through acquisitions include obtaining proprietary rights to products or services, increasing market power by purchasing competitors, shoring up weaknesses in key business areas, penetrating new geographic regions, or providing managers with new opportunities for career growth and advancement. Since mergers and acquisitions are so complex, however, it can be very difficult to evaluate the transaction, define the associated costs and benefits, and handle the resulting tax and legal issues.

"In today's global business environment, companies may have to grow to survive, and one of the best ways to grow is by merging with another company or acquiring other companies," consultant Jacalyn Sherriton told Robert McGarvey in an interview for Entrepreneur. "Massive, multibillion-dollar corporations are becoming the norm, leaving an entrepreneur to wonder whether a merger ought to be in his or her plans, too," McGarvey continued.

When a small business owner chooses to merge with or sell out to another company, it is sometimes called "harvesting" the small business. In this situation, the transaction is intended to release the value locked up in the small business for the benefit of its owners and investors. The impetus for a small business owner to pursue a sale or merger may involve estate planning, a need to diversify his or her investments, an inability to finance growth independently, or a simple need for change. In addition, some small businesses find that the best way to grow and compete against larger firms is to merge with or acquire other small businesses.

In principle, the decision to merge with or acquire another firm is a capital budgeting decision much like any other. But mergers differ from ordinary investment decisions in at least five ways. First, the value of a merger may depend on such things as strategic fits that are difficult to measure. Second, the accounting, tax, and legal aspects of a merger can be complex. Third, mergers often involve issues of corporate control and are a means of replacing existing management. Fourth, mergers obviously affect the value of the firm, but they also affect the relative value of the stocks and bonds. Finally, mergers are often "unfriendly."

Types of Acquisitions

In general, acquisitions can be horizontal, vertical, or conglomerate. A horizontal acquisition takes place between two firms in the same line of business. For example, one tool and die company might purchase another. In contrast, a vertical merger entails expanding forward or backward in the chain of distribution, toward the source of raw materials or toward the ultimate consumer. For example, an auto parts manufacturer might purchase a retail auto parts store. A conglomerate is formed through the combination of unrelated businesses.

Another type of combination of two companies is a consolidation. In a consolidation, an entirely new firm is created, and the two previous entities cease to exist. Consolidated financial statements are prepared under the assumption that two or more corporate entities are in actuality only one. The consolidated statements are prepared by combining the account balances of the individual firms after certain adjusting and eliminating entries are made.

Another way to acquire a firm is to buy the voting stock. This can be done by agreement of management or by tender offer. In a tender offer, the acquiring firm makes the offer to buy stock directly to the shareholders, thereby bypassing management. In contrast to a merger, a stock acquisition requires no stockholder voting. Shareholders wishing to keep their stock can simply do so. Also, a minority of shareholders may hold out in a tender offer.

A bidding firm can also buy another simply by purchasing all its assets. This involves a costly legal transfer of title and must be approved by the shareholders of the selling firm. A takeover is the transfer of control from one group to another. Normally, the acquiring firm (the bidder) makes an offer for the target firm. In a proxy contest, a group of dissident shareholders will seek to obtain enough votes to gain control of the board of directors.

Taxable Versus Tax-Free Transactions

Mergers and acquisitions can be either tax-free or taxable events. The tax status of a transaction may affect its value from both the buyer's and the seller's viewpoints. In a taxable acquisition, the assets of the selling firm are revalued or "written up." Therefore, the depreciation deduction will rise (assets are not revalued in a tax-free acquisition). But the selling shareholders will have to pay capital gains taxes and thus will want more for their shares to compensate. This is known as the capital gains effect. The capital gains and write-up effects tend to cancel each other out.

Certain exchanges of stock are considered tax-free reorganizations, which permit the owners of one company to exchange their shares for the stock of the acquirer without paying taxes. There are three basic types of tax-free reorganizations. In order for a transaction to qualify as a type A tax-free reorganization, it must be structured in certain ways. In contrast to a type B reorganization, the type A transaction allows the buyer to use either voting or nonvoting stock. It also permits the buyer to use more cash in the total consideration since the law does not stipulate a maximum amount of cash that can be used. At least 50 percent of the consideration, however, must be stock in the acquiring corporation. In addition, in a type A reorganization, the acquiring corporation may choose not to purchase all the target's assets.

In instances where at least 50 percent of the bidder's stock is used as the consideration—but other considerations such as cash, debt, or nonequity securities are also used—the transaction may be partially taxable. Capital gains taxes must be paid on those shares that were exchanged for nonequity consideration.

A type B reorganization requires that the acquiring corporation use mainly its own voting common stock as the consideration for purchase of the target corporation's common stock. Cash must comprise no more than 20 percent of the total consideration, and at least 80 percent of the target's stock must be paid for by voting stock by the bidder.

Target stockholders who receive the stock of the acquiring corporation in exchange for their common stock are not immediately taxed on the consideration they receive. Taxes will have to be paid only if the stock is eventually sold. If cash is included in the transaction, this cash may be taxed to the extent that it represents a gain on the sale of stock.

In a type C reorganization, the acquiring corporation must purchase 80 percent of the fair market value of the target's assets. In this type of reorganization, a tax liability results when the acquiring corporation purchases the assets of the target using consideration other than stock in the acquiring corporation. The tax liability is measured by comparing the purchase price of the assets with the adjusted basis of these assets.

Financial Accounting for Mergers and Acquisitions

The two principal accounting methods used in mergers and acquisitions are the pooling of interests method and the purchase method. The main difference between them is the value that the combined firm's balance sheet places on the assets of the acquired firm, as well as the depreciation allowances and charges against income following the merger.

The pooling of interests method assumes that the transaction is simply an exchange of equity securities. Therefore, the capital stock account of the target firm is eliminated, and the acquirer issues new stock to replace it. The two firms' assets and liabilities are combined at their historical book values as of the acquisition date. The end result of a pooling of interests transaction is that the total assets of the combined firm are equal to the sum of the assets of the individual firms. No goodwill is generated, and there are no charges against earnings. A tax-free acquisition would normally be reported as a pooling of interests.

Under the purchase method, assets and liabilities are shown on the merged firm's books at their market (not book) values as of the acquisition date. This method is based on the idea that the resulting values should reflect the market values established during the bargaining process. The total liabilities of the combined firm equal the sum of the two firms' individual liabilities. The equity of the acquiring firm is increased by the amount of the purchase price.

Accounting for the excess of cost over the aggregate of the fair market values of the identifiable net assets acquired applies only in purchase accounting. The excess is called goodwill, an asset which is charged against income and amortized over a period that cannot exceed 40 years. Although the amortization "expense" is deducted from reported income, it cannot be deducted for tax purposes.

Purchase accounting usually results in increased depreciation charges because the book value of most assets is usually less than fair value because of inflation. For tax purposes, however, depreciation does not increase because the tax basis of the assets remains the same. Since depreciation under pooling accounting is based on the old book values of the assets, accounting income is usually higher under the pooling method. The accounting treatment has no cash flow consequences. Thus, value should be unaffected by accounting procedure. However, some firms may dislike the purchase method because of the goodwill created. The reason for this is that goodwill is amortized over a period of years.

How to Value an Acquisition Candidate

Valuing an acquisition candidate is similar to valuing any investment. The analyst estimates the incremental cash flows, determines an appropriate risk-adjusted discount rate, and then computes the net present value (NPV). If firm A is acquiring firm B, for example, then the acquisition makes economic sense if the value of the combined firm is greater than the value of firm A plus the value of firm B. Synergy is said to exist when the cash flow of the combined firm is greater than the sum of the cash flows for the two firms as separate companies. The gain from the merger is the present value of this difference in cash flows.

SOURCES OF GAINS FROM ACQUISITIONS. The gains from an acquisition may result from one or more of the following five categories:1) revenue enhancement, 2) cost reductions, 3) lower taxes, 4) changing capital requirements, or 5) a lower cost of capital. Increased revenues may come from marketing gains, strategic benefits, and market power. Marketing gains arise from more effective advertising, economies of distribution, and a better mix of products. Strategic benefits represent opportunities to enter new lines of business. Finally, a merger may reduce competition, thereby increasing market power. Such mergers, of course, may run afoul of antitrust legislation.

A larger firm may be able to operate more efficiently than two smaller firms, thereby reducing costs. Horizontal mergers may generate economies of scale. This means that the average production cost will fall as production volume increases. A vertical merger may allow a firm to decrease costs by more closely coordinating production and distribution. Finally, economies may be achieved when firms have complementary resources—for example, when one firm has excess production capacity and another has insufficient capacity.

Tax gains in mergers may arise because of unused tax losses, unused debt capacity, surplus funds, and the write-up of depreciable assets. The tax losses of target corporations can be used to offset the acquiring corporation's future income. These tax losses can be used to offset income for a maximum of 15 years or until the tax loss is exhausted. Only tax losses for the previous three years can be used to offset future income.

Tax loss carry-forwards can motivate mergers and acquisitions. A company that has earned profits may find value in the tax losses of a target corporation that can be used to offset the income it plans to earn. A merger may not, however, be structured solely for tax purposes. In addition, the acquirer must continue to operate the pre-acquisition business of the company in a net loss position. The tax benefits may be less than their "face value," not only because of the time value of money, but also because the tax loss carry-forwards might expire without being fully utilized.

Tax advantages can also arise in an acquisition when a target firm carries assets on its books with basis, for tax purposes, below their market value. These assets could be more valuable, for tax purposes, if they were owned by another corporation that could increase their tax basis following the acquisition. The acquirer would then depreciate the assets based on the higher market values, in turn, gaining additional depreciation benefits.

Interest payments on debt are a tax-deductible expense, whereas dividend payments from equity ownership are not. The existence of a tax advantage for debt is an incentive to have greater use of debt, as opposed to equity, as the means of financing merger and acquisition transactions. Also, a firm that borrows much less than it could may be an acquisition target because of its unused debt capacity. While the use of financial leverage produces tax benefits, debt also increases the likelihood of financial distress in the event that the acquiring firm cannot meet its interest payments on the acquisition debt.

Finally, a firm with surplus funds may wish to acquire another firm. The reason is that distributing the money as a dividend or using it to repurchase shares will increase income taxes for shareholders. With an acquisition, no income taxes are paid by shareholders.

Acquiring firms may be able to more efficiently utilize working capital and fixed assets in the target firm, thereby reducing capital requirements and enhancing profitability. This is particularly true if the target firm has redundant assets that may be divested.

The cost of debt can often be reduced when two firms merge. The combined firm will generally have reduced variability in its cash flows. Therefore, there may be circumstances under which one or the other of the firms would have defaulted on its debt, but the combined firm will not. This makes the debt safer, and the cost of borrowing may decline as a result. This is termed the coinsurance effect.

Diversification is often cited as a benefit in mergers. Diversification by itself, however, does not create any value because stockholders can accomplish the same thing as the merger by buying stock in both firms.

VALUATION PROCEDURES. The procedure for valuing an acquisition candidate depends on the source of the estimated gains. Different sources of synergy have different risks. Tax gains can be estimated fairly accurately and should be discounted at the cost of debt. Cost reductions through operating efficiencies can also be determined with some confidence. Such savings should be discounted at a normal weighted average cost of capital. Gains from strategic benefits are difficult to estimate and are often highly uncertain. A discount rate greater than the overall cost of capital would thus be appropriate.

The net present value (NPV) of the acquisition is equal to the gains less the cost of the acquisition. The cost depends on whether cash or stock is used as payment. The cost of an acquisition when cash is used is just the amount paid. The cost of the merger when common stock is used as the consideration (the payment) is equal to the percentage of the new firm that is owned by the previous shareholders in the acquired firm multiplied by the value of the new firm. In a cash merger the benefits go entirely to the acquiring firm, whereas in a stock-for-stock exchange the benefits are shared by the acquiring and acquired firms.

Whether to use cash or stock depends on three considerations. First, if the acquiring firm's management believes that its stock is overvalued, then a stock acquisition may be cheaper. Second, a cash acquisition is usually taxable, which may result in a higher price. Third, the use of stock means that the acquired firm will share in any gains from merger; if the merger has a negative NPV, however, then the acquired firm will share in the loss.

In valuing acquisitions, the following factors should be kept in mind. First, market values must not be ignored. Thus, there is no need to estimate the value of a publicly traded firm as a separate entity. Second, only those cash flows that are incremental are relevant to the analysis. Third, the discount rate used should reflect the risk associated with the incremental cash flows. Therefore, the acquiring firm should not use its own cost of capital to value the cash flows of another firm. Finally, acquisition may involve significant investment banking fees and costs.

Hostile Acquisitions

The replacement of poor management is a potential source of gain from acquisition. Changing technological and competitive factors may lead to a need for corporate restructuring. If incumbent management is unable to adapt, then a hostile acquisition is one method for accomplishing change.

Hostile acquisitions generally involve poorly performing firms in mature industries, and occur when the board of directors of the target is opposed to the sale of the company. In this case, the acquiring firm has two options to proceed with the acquisition—a tender offer or a proxy fight. A tender offer represents an offer to buy the stock of the target firm either directly from the firm's shareholders or through the secondary market. In a proxy fight, the acquirer solicits the shareholders of the target firm in an attempt to obtain the right to vote their shares. The acquiring firm hopes to secure enough proxies to gain control of the board of directors and, in turn, replace the incumbent management.

Management in target firms will typically resist takeover attempts either to get a higher price for the firm or to protect their own self-interests. This can be done a number of ways. Target companies can decrease the likelihood of a takeover though charter amendments. With the staggered board technique, the board of directors is classified into three groups, with only one group elected each year. Thus, the suitor cannot obtain control of the board immediately even though it may have acquired a majority ownership of the target via a tender offer. Under a supermajority amendment, a higher percentage than 50 percent—generally two-thirds or 80 percent—is required to approve a merger.

Other defensive tactics include poison pills and dual class recapitalizations. With poison pills, existing shareholders are issued rights which, if a bidder acquires a certain percentage of the outstanding shares, can be used to purchase additional shares at a bargain price, usually half the market price. Dual class recapitalizations distribute a new class of equity with superior voting rights. This enables the target firm's managers to obtain majority control even though they do not own a majority of the shares.

Other preventative measures occur after an unsolicited offer is made to the target firm. The target may file suit against the bidder alleging violations of antitrust or securities laws. Alternatively, the target may engage in asset and liability restructuring to make it an unattractive target. With asset restructuring, the target purchases assets that the bidder does not want or that will create antitrust problems, or sells off the assets that the suitor desires to obtain. Liability restructuring maneuvers include issuing shares to a friendly third party to dilute the bidder's ownership position or leveraging up the firm through a leveraged recapitalization making it difficult for the suitor to finance the transaction.

Other postoffer tactics involve targeted share repurchases (often termed "greenmail")—in which the target repurchases the shares of an unfriendly suitor at a premium over the current market price—and golden parachutes—which are lucrative supplemental compensation packages for the target firm's management. These packages are activated in the case of a takeover and the subsequent resignations of the senior executives. Finally, the target may employ an exclusionary self-tender. With this tactic, the target firm offers to buy back its own stock at a premium from everyone except the bidder.

A privately owned firm is not subject to unfriendly takeovers. A publicly traded firm "goes private" when a group, usually involving existing management, buys up all the publicly held stock. Such transactions are typically structured as leveraged buyouts (LBOs). LBOs are financed primarily with debt secured by the assets of the target firm.

Do Acquisitions Benefit Shareholders?

There is substantial empirical evidence that the shareholders in acquired firms benefit substantially. Gains for this group typically amount to 20 percent in mergers and 30 percent in tender offers above the market prices prevailing a month prior to the merger announcement.

The gains to acquiring firms are difficult to measure. The best evidence suggests that shareholders in bidding firms gain little. Losses in value subsequent to merger announcements are not unusual. This seems to suggest that overvaluation by bidding firms is common. Managers may also have incentives to increase firm size at the potential expense of shareholder wealth. If so, merger activity may happen for noneconomic reasons, to the detriment of shareholders.

Mergers and Acquisitions

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Mergers and acquisitions are means by which corporations combine with each other. Mergers occur when two or more corporations become one. To protect shareholders, state law provides procedures for the merger. A vote of the board of directors and then a vote of the shareholders of both corporations is usually required. Following a merger, the two corporations cease to exist as separate entities. In the classic merger, the assets and liabilities of one corporation are automatically transferred to the other. Shareholders of the disappearing company become shareholders in the surviving company or receive compensation for their shares.

Mergers may come as the result of a negotiation between two corporations interested in combining, or when one or more corporations "target" another for acquisition. Combinations that occur with the approval and encouragement of the target company's management are called "friendly" mergers; combinations that occur despite opposition from the target company are called "hostile" mergers or takeovers. In either case, these consolidations can bring together corporations of roughly the same size and market power, or corporations of vastly different sizes and market power.

The term "acquisition" is typically used when one company takes control of another. This can occur through a merger or a number of other methods, such as purchasing the majority of a company's stock or all of its assets. In a purchase of assets, the transaction is one that must be negotiated with the management of the target company. Compared to a merger, an acquisition is treated differently for tax purposes, and the acquiring company does not necessarily assume the liabilities of the target company.

A "tender offer" is a popular way to purchase a majority of shares in another company. The acquiring company makes a public offer to purchase shares from the target company's shareholders, thus bypassing the target company's management. In order to induce the shareholders to sell, or "tender, " their shares, the acquiring company typically offers a purchase price higher than market value, often substantially higher. Certain conditions are often placed on a tender offer, such as requiring the number of shares tendered be sufficient for the acquiring company to gain control of the target. If the tender offer is successful and a sufficient percentage of shares are acquired, control of the target company through the normal methods of shareholder democracy can be taken and thereafter the target company's management replaced. The acquiring company can also use their control of the target company to bring about a merger of the two companies.

Often, a successful tender offer is followed by a "cash-out merger." The target company (now controlled by the acquiring company) is merged into the acquiring company, and the remaining shareholders of the target company have their shares transformed into a right to receive a certain amount of cash.

Another common merger variation is the "triangular" merger, in which a subsidiary of the surviving company is created and then merged with the target. This protects the surviving company from the liabilities of the target by keeping them within the subsidiary rather than the parent. A "reverse triangular merger" has the acquiring company create a subsidiary, which is then merged into the target company. This form preserves the target company as an ongoing legal entity, though its control has passed into the hands of the acquirer.

Reasons for Mergers and Acquisitions

There are a number of reasons why a corporation will merge with, acquire, or be acquired by another corporation. Sometimes, corporations can produce goods or services more efficiently if they combine their efforts and facilities. These efficiency gains may come simply by virtue of the size of the combined company; it may be cheaper to produce goods on a larger scale. Collaborating or sharing expertise may achieve gains in efficiency, or a company might have underutilized assets the other company can better use. Also, a change in management may make the company more profitable. Other reasons for acquisitions have to do more with hubris and power. The management of an acquiring company may be motivated more by the desire to manage ever-larger companies than by any possible gains in efficiency.

Regulation of Mergers and Acquisitions

Mergers and acquisitions are governed by both state and federal laws. State law sets the procedures for the approval of mergers and establishes judicial oversight for the terms of mergers to ensure shareholders of the target company receive fair value. State law also governs the extent to which the management of a target company can protect itself from a hostile takeover through various financial and legal defenses. Generally, state law tends to be deferential to defenses as long as the target company is not acting primarily to preserve its own positions. Courts tend to be skeptical of defenses if the management of a target company has already decided to sell the company or to bring about a change of control. Because of the fear that mergers will negatively affect employees or other company stakeholders, most states allow directors at target companies to defend against acquisitions. Because of the number of state defenses now available, the vast majority of mergers and acquisitions are friendly, negotiated transactions.

The federal government oversees corporate consolidations to ensure that the combined size of the new corporation does not have such monopolistic power as to be unlawful under the Sherman Antitrust Act. The federal government also regulates tender offers through the Williams Act, which requires anyone purchasing more than 5 percent of a company's shares to identify herself and make certain public disclosures, including an announcement of the purpose of the share purchase and of any terms of a tender offer. The act also requires that an acquirer who raises his or her price during the term of a tender offer, raise it for any stock already tendered, that acquirers hold tender offers open for twenty business days, and that acquirers not commit fraud.

History

Merger and acquisition activity in the United States has typically run in cycles, with peaks coinciding with periods of strong business growth. U.S. merger activity has been marked by five prominent waves: one around the turn of the twentieth century, the second peaking in 1929, the third in the latter half of the 1960s, the fourth in the first half of the 1980s, and the fifth in the latter half of the 1990s.

This last peak, in the final years of the twentieth century, brought very high levels of merger activity. Bolstered by a strong stock market, businesses merged at an unprecedented rate. The total dollar volume of mergers increased throughout the 1990s, setting new records each year from 1994 to 1999. Many of the acquisitions involved huge companies and enormous dollar amounts. Disney acquired ABC Capital Cities for $19 billion, Bell Atlantic acquired Nynex for $22 billion, WorldCom acquired MCI for $41.9 billion, SBC Communications acquired Ameritech for $56.6 billion, Traveler's acquired Citicorp for $72.6 billion, Nation Bank acquired Bank of America for $61.6 billion, Daimler-Benz acquired Chrysler for $39.5 billion, and Exxon acquired Mobil for $77.2 billion.

Bibliography

Carney, William J. Mergers and Acquisitions. New York: Foundation Press, 2000.

Scherer, F. M., and David Ross. Industrial Market Structure and Market Performance. Chicago: Rand McNally, 1970.

West's Encyclopedia of American Law:

Mergers and Acquisitions

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This entry contains information applicable to United States law only.

Methods by which corporations legally unify ownership of assets formerly subject to separate controls.

A merger or acquisition is a combination of two companies where one corporation is completely absorbed by another corporation. The less important company loses its identity and becomes part of the more important corporation, which retains its identity. A merger extinguishes the merged corporation, and the sur- viving corporation assumes all the rights, privileges, and liabilities of the merged corporation. A merger is not the same as a consolidation, in which two corporations lose their separate identities and unite to form a completely new corporation.

Federal and state laws regulate mergers and acquisitions. Regulation is based on the concern that mergers inevitably eliminate competition between the merging firms. This concern is most acute where the participants are direct rivals, because courts often presume that such arrangements are more prone to restrict output and increase prices. The fear that mergers and acquisitions reduce competition has meant that the government carefully scrutinizes proposed mergers. On the other hand, since the 1980s the federal government has become less aggressive in seeking the prevention of mergers.

Despite concerns about a lessening of competition, U.S. law has left firms relatively free to buy or sell entire companies or specific parts of a company. Mergers and acquisitions often result in a number of social benefits. Mergers can bring better management or technical skill to bear on underused assets. Mergers can also produce economies of scale and scope that reduce costs, improve quality, and increase output. The possibility of a takeover can discourage company managers from behaving in ways that fail to maximize profits. A merger can enable a business owner to sell the firm to someone who is already familiar with the industry and who would be in a better position to pay the highest price. The prospect of a lucrative sale induces entrepreneurs to form new firms. Finally, many mergers pose few risks to competition.

Antitrust merger law seeks to prohibit transactions whose probable anticompetitive consequences outweigh their likely benefits. The critical time for review usually is when the merger is first proposed. This requires enforcement agencies and courts to forecast market trends and future effects. Merger cases examine past events or periods to understand each merging party's position in its market and to predict the merger's competitive impact.

Types of Mergers

There are three types of mergers, based on the competitive relationships between the merging parties. In a horizontal merger, one firm acquires another firm that produces and sells an identical or similar product in the same geographic area and thereby eliminates competition between the two firms. In a vertical merger, one firm acquires either a customer or a supplier. Conglomerate mergers encompass all other acquisitions, including pure conglomerate transactions where the merging parties have no evident relationship (a shoe producer buys an appliance manufacturer), geographic extension mergers, where the buyer makes the same product as the target firm but does so in a different geographic market (a baker in Chicago buys a bakery in Miami), and product extension mergers, where a firm producing one product buys a firm that makes a different product that requires the application of similar manufacturing or marketing techniques (a producer of household detergents buys a producer of liquid bleach).

Corporate Merger Procedures

State statutes establish procedures to accomplish corporate mergers. Generally, the board of directors for each corporation must initially pass a resolution adopting a plan of merger that specifies the names of the corporations that are involved, the name of the proposed merged company, the manner of converting shares of both corporations, and any other legal provision to which the corporations agree. Each corporation notifies all its shareholders that a meeting will be held to approve the merger. If the proper number of shareholders approves the plan, the directors sign the papers and file them with the state. The secretary of state issues a certificate of merger to authorize the new corporation.

Some statutes permit the directors to abandon the plan at any point up to the filing of the final papers. States with the most liberal corporation laws permit a surviving corporation to absorb another company by merger without submitting the plan to its shareholders for approval unless otherwise required in its certificate of incorporation.

Statutes often provide that corporations formed in two different states must follow the rules in their respective states for a merger to be effective. Some corporation statutes require the surviving corporation to purchase the shares of stockholders who voted against the merger.

Competitive Concerns

Horizontal, vertical, and conglomerate mergers each raise distinctive competitive concerns.

Horizontal Mergers

Horizontal mergers raise three basic competitive problems. The first is the elimination of competition between the merging firms, which, depending on their size, may be significant. The second is that the unification of the merging firms' operations may create substantial market power and could enable the merged entity to raise prices by reducing output unilaterally. The third problem is that, by increasing concentration in the relevant market, the transaction may strengthen the ability of the market's remaining participants to coordinate their pricing and output decisions. The fear is not that the entities will engage in secret collaboration but that the reduction in the number of industry members will enhance tacit coordination of behavior.

Vertical Mergers

Vertical mergers take two basic forms: forward integration, by which a firm buys a customer, and backward integration, by which a firm acquires a supplier. Replacing market exchanges with internal transfers can offer at least two major benefits. First, the vertical merger internalizes all transactions between manufacturer and its supplier or dealer, thus converting a potentially adversarial relationship into something more like a partnership. Second, internalization can give management more effective ways to monitor and improve performance.

Vertical integration by merger does not reduce the total number of economic entities operating at one level of the market, but it may change patterns of industry behavior. Whether a forward or backward integration, the newly acquired firm may decide to deal only with the acquiring firm, thereby altering competition among the acquiring firm's suppliers, customers, or competitors. Suppliers may lose a market for their goods, retail outlets may be deprived of supplies, or competitors may find that both supplies and outlets are blocked. This raises the concern that vertical integration will foreclose competitors by limiting their access to sources of supply or to customers. Vertical mergers may also be anticompetitive because their entrenched market power may impede new businesses from entering the market.

Conglomerate Mergers

Conglomerate transactions take many forms, ranging from short-term joint ventures to complete mergers. Whether a conglomerate merger is pure, geographical, or a product line extension, it involves firms that operate in separate markets. Therefore, a conglomerate transaction ordinarily has no direct effect on competition. There is no reduction or other change in the number of firms in either the acquiring or acquired firm's market.

Conglomerate mergers can supply a market or "demand" for firms, thus giving entrepreneurs liquidity at an open market price and with a key inducement to form new enterprises. The threat of takeover may force existing managers to increase efficiency in competitive markets. Conglomerate mergers also provide opportunities for firms to reduce capital costs and overhead and achieve other efficiencies.

Conglomerate mergers, however, may lessen future competition by eliminating the possibility that the acquiring firm would have entered the acquired firm's market independently. A conglomerate merger also may convert a large firm into a dominant company with a decisive competitive advantage or otherwise make it difficult for other companies to enter the market. This type of merger may also reduce the number of smaller firms and increase the merged firm's political power, thereby impairing the social and political goals of retaining independent decision-making centers, guaranteeing small business opportunities, and preserving democratic processes.

Federal Antitrust Regulation

Since the late nineteenth century, the federal government has challenged business practices and mergers that create or may create a monopoly in a particular market. Federal legislation has varied in effectiveness in preventing anticompetitive mergers.

Sherman Anti-Trust Act of 1890

The Sherman Act (15 U.S.C.A. § 1 et seq.) was the first federal antitrust statute. Its application to mergers and acquisitions has varied, depending on its interpretation by the U.S. Supreme Court. In Northern Securities Co. v. United States, 193 U.S. 197, 24 S. Ct. 436, 48 L. Ed. 679 (1904), the Court ruled that all mergers between directly competing firms constituted a combination in restraint of trade and therefore violated section 1 of the Sherman Act. This decision hindered the creation of new monopolies through horizontal mergers.

In Standard Oil Co. of New Jersey v. United States, 221 U.S. 1, 31 S. Ct. 502, 55 L. Ed. 619 (1911), however, the Court adopted a less stringent "rule of reason test" to evaluate mergers. This rule meant that the courts must examine whether the merger would yield monopoly control to the merged entity. In practice this resulted in the approval of many mergers that approached but did not achieve monopoly power.

Clayton Anti-Trust Act of 1914

Congress passed the Clayton Act (15 U.S.C.A. § 12 et seq.) in response to the Standard Oil Co. of New Jersey decision, which it feared would undermine the Sherman Act's ban against trade restraints and monopolization. Among the provisions of the Clayton Act was section 7, which barred anticompetitive stock acquisitions.

The original section 7 was a weak antimerger safeguard because it banned only purchases of stock. Businesses soon realized that they could evade this measure simply by buying the target firm's assets. The Supreme Court, in Thatcher Manufacturing Co. v. Federal Trade Commission, 272 U.S. 554, 47 S. Ct. 175, 71 L. Ed. 405 (1926), further undermined section 7 by allowing a firm to escape liability if it bought a controlling interest in a rival firm's stock and used this control to transfer to itself the target's assets before the government filed a complaint. Thus, a firm could circumvent section 7 by quickly converting a stock acquisition into a purchase of assets.

By the 1930s section 7 was eviscerated. Between the passage of the Clayton Act in 1914 and 1950, only fifteen mergers were overturned under the antitrust laws, and ten of these dissolutions were based on the Sherman Act. In 1950 Congress responded to post-World War II concerns that a wave of corporate acquisitions was threatening to undermine U.S. society by passing the Celler-Kefauver Antimerger Act, which amended section 7 of the Clayton Act to close the assets loophole. Section 7 now prohibited a business from purchasing the stock or assets of another entity if "the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly."

Congress intended the amended section to reach vertical and conglomerate mergers, as well as horizontal mergers. The U.S. Supreme Court, in Brown Shoe Co. v. United States, 370 U.S. 294, 82 S. Ct. 1502, 8 L. Ed. 2d 510 (1962), interpreted the amended law as a congressional attempt to retain local control over industry and to protect small business. The Court concluded that it must look at the merger's actual and likely effect on competition. In general, however, the Court relied almost entirely on market share and concentration figures in evaluating whether a merger was likely to be anticompetitive. Nevertheless, the general presumption was that mergers were suspect.

In United States v. General Dynamics, 415 U.S. 486, 94 S. Ct. 1186, 39 L. Ed. 2d 530 (1974), the Court changed direction. It rejected any antitrust analysis that focused exclusively on market share statistics, cautioning that although statistical data can be of great significance, they are "not conclusive indicators of anticompetitive effects." A merger must be viewed in the context of its particular industry. Therefore, the Court held that "only a further examination of the particular market — its structure, history, and probable future — can provide the appropriate setting for judging the probable anticompetitive effect of the merger." This totality-of-the-circumstances approach has remained the standard for conducting an antitrust analysis of a proposed merger.

Federal Trade Commission Act of 1975

\E Section 5 of the Federal Trade Commission Act (15 U.S.C.A. § 45), prohibits "unfair method[s] of competition" and gives the Federal Trade Commission (FTC) independent jurisdiction to enforce the antitrust laws. The law provides no criminal penalties and limits the FTC to issuing prospective decrees. The Justice Department and the FTC share enforcement of the Clayton Act. Congress gave this authority to the FTC because it thought an administrative body would be more responsive to congressional goals than the courts.

Hart-Scott-Rodino Antitrust Improvements Act of 1976

The Hart-Scott-Rodino Antitrust Improvements Act (HSR) (15 U.S.C.A. § 18a) established a mandatory premerger notification procedure for firms that are parties to certain mergers. The HSR process requires the merging parties to notify the FTC and the Justice Department before completing certain transactions. In general, an HSR premerger filing is required when (a) one of the parties to the transaction has annual net sales (or revenues) or total assets exceeding $100 million and the other party has annual net sales (or revenues) or total assets exceeding $10 million, and (b) the acquisition price or value of the acquired assets or entity exceeds $15 million. Failure to comply with these requirements can result in the rescission of completed transactions and can be punished by a civil penalty of up to $10,000 per day.

HSR also established mandatory waiting periods during which the parties may not "close" the proposed transaction and begin joint operations. In transactions other than cash tender offers, the initial waiting period is thirty days after the merging parties have made the requisite premerger notification filings with the federal agencies. For cash tender offers, the waiting period is fifteen days after the premerger filings. Before the initial waiting periods expire, the federal agency responsible for reviewing the transaction can request the parties to supply additional information relating to the proposed merger. These "second requests" often include extensive interrogatories (lists of questions to be answered) and broad demands for the production of documents. A request for further information can be made once, and the issuance of a second request extends the waiting period for ten days for cash tender offers and twenty days for all other transactions. These extensions of the waiting period do not begin until the merging parties are in "substantial compliance" with the government agency's request for additional information.

If the federal government decides not to challenge a merger before the HSR waiting period expires, a federal agency is highly unlikely to sue at a late date to dissolve the transaction under section 7 of the Clayton Act. The federal government is not legally barred from bringing such a lawsuit, but the desire of the federal agencies to increase predictability for business planners has made the HSR process the critical period for federal review. However, the decision of a federal agency not to attack a merger during the HSR waiting period does not preclude a lawsuit by a state government or a private entity. To facilitate analysis by the state attorneys general, the National Association of Attorneys General (NAAG) has issued a Voluntary Pre-Merger Disclosure Compact under which the merging parties can submit copies of their federal HSR filings and the responses to second requests with NAAG for circulation among states that have adopted the compact.

Merger Guidelines

In the vast majority of antitrust challenges to mergers and acquisitions, the matters have been resolved by consent order or decree. The Justice Department and the FTC have sought to clarify how they analyze mergers through merger guidelines issued May 5, 1992 (4 Trade Reg. Rep. [CCH] ¶ 13,104). These guidelines are not "law" but enforcement policy statements. Nevertheless, the antitrust enforcement agencies will use them to analyze proposed transactions.

The 1992 merger guidelines state that most horizontal mergers and acquisitions aid competition and are beneficial to consumers. The intent of issuing the guidelines is to "avoid unnecessary interference with the larger universe of mergers that are either competitively beneficial or neutral."

The guidelines prescribe five questions for identifying hazards in proposed horizontal mergers: Does the merger cause a significant increase in concentration and produce a concentrated market? Does the merger appear likely to cause adverse competitive effects? Would entry sufficient to frustrate anticompetitive conduct be timely and likely to occur? Will the merger generate efficiencies that the parties could not reasonably achieve through other means? Is either party likely to fail, and will its assets leave the market if the merger does not occur?

The guidelines essentially ask which products or firms are now available to buyers and where could buyers turn for supplies if relative prices increased by five percent (the measure for assessing a merger-generated price increase). The guidelines redraw market boundaries to cover more products and a greater area, which tends to yield lower concentration increases than Supreme Court merger decisions of the 1960s.

The Future of Mergers and Acquisitions

Beginning in 1980, with President Ronald Reagan's administration, the federal government has adjusted its policies to allow more horizontal mergers and acquisitions. The states have responded by invoking their antitrust laws to scrutinize these types of transactions. Nevertheless, mergers and acquisitions have increased throughout the U.S. economy, including the health care industry, electric utilities, telecommunications corporations, and national defense contractors.

See: Antitrust Law; Golden Parachute; Junk Bond; Restraint of Trade; Scorched-Earth Plan; Sherman Anti-Trust Act; Unfair Competition.

Investopedia Financial Dictionary:

Mergers And Acquisitions - M&A

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A general term used to refer to the consolidation of companies. A merger is a combination of two companies to form a new company, while an acquisition is the purchase of one company by another in which no new company is formed.

Investopedia Says:
An example of a major merger is the merging of JDS Fitel Inc. and Uniphase Corp. in 1999 to form JDS Uniphase. An example of a major acquisition is Manulife Financial Corporation's 2004 acquisition of John Hancock Financial Services Inc.

The term M&A also refers to the department at financial institutions that deals with mergers and acquisitions.

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Mergers and acquisitions

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"Merger" redirects here. For other uses, see Merge (disambiguation). For other uses of "acquisition", see Acquisition (disambiguation).

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Mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or new location, without creating a subsidiary, other child entity or using a joint venture. The distinction between a "merger" and an "acquisition" has become increasingly blurred in various respects (particularly in terms of the ultimate economic outcome), although it has not completely disappeared in all situations.

Look up merger in Wiktionary, the free dictionary.

Acquisition

Main article: Takeover

An acquisition is the purchase of one business or company by another company or other business entity. Consolidation occurs when two companies combine together to form a new enterprise altogether, and neither of the previous companies survives independently. Acquisitions are divided into "private" and "public" acquisitions, depending on whether the acquiree or merging company (also termed a target) is or is not listed on public stock markets. An additional dimension or categorization consists of whether an acquisition is friendly or hostile.

Achieving acquisition success has proven to be very difficult, while various studies have shown that 50% of acquisitions were unsuccessful.^[1] The acquisition process is very complex, with many dimensions influencing its outcome.^[2]

Whether a purchase is perceived as being a "friendly" one or a "hostile" depends significantly on how the proposed acquisition is communicated to and perceived by the target company's board of directors, employees and shareholders. It is normal for M&A deal communications to take place in a so-called 'confidentiality bubble' wherein the flow of information is restricted pursuant to confidentiality agreements.^[3] In the case of a friendly transaction, the companies cooperate in negotiations; in the case of a hostile deal, the board and/or management of the target is unwilling to be bought or the target's board has no prior knowledge of the offer. Hostile acquisitions can, and often do, ultimately become "friendly", as the acquiror secures endorsement of the transaction from the board of the acquiree company. This usually requires an improvement in the terms of the offer and/or through negotiation.

"Acquisition" usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger and/or longer-established company and retain the name of the latter for the post-acquisition combined entity. This is known as a reverse takeover. Another type of acquisition is the reverse merger, a form of transaction that enables a private company to be publicly listed in a relatively short time frame. A reverse merger occurs when a privately held company (often one that has strong prospects and is eager to raise financing) buys a publicly listed shell company, usually one with no business and limited assets.^[4]

There are also a variety of structures used in securing control over the assets of a company, which have different tax and regulatory implications:

This section does not cite any references or sources. Please help improve this section by adding citations to reliable sources. Unsourced material may be challenged and removed. (June 2008)

The buyer buys the shares, and therefore control, of the target company being purchased. Ownership control of the company in turn conveys effective control over the assets of the company, but since the company is acquired intact as a going concern, this form of transaction carries with it all of the liabilities accrued by that business over its past and all of the risks that company faces in its commercial environment.
The buyer buys the assets of the target company. The cash the target receives from the sell-off is paid back to its shareholders by dividend or through liquidation. This type of transaction leaves the target company as an empty shell, if the buyer buys out the entire assets. A buyer often structures the transaction as an asset purchase to "cherry-pick" the assets that it wants and leave out the assets and liabilities that it does not. This can be particularly important where foreseeable liabilities may include future, unquantified damage awards such as those that could arise from litigation over defective products, employee benefits or terminations, or environmental damage. A disadvantage of this structure is the tax that many jurisdictions, particularly outside the United States, impose on transfers of the individual assets, whereas stock transactions can frequently be structured as like-kind exchanges or other arrangements that are tax-free or tax-neutral, both to the buyer and to the seller's shareholders.

The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where one company splits into two, generating a second company separately listed on a stock exchange.

As per knowledge-based views, firms can generate greater values through the retention of knowledge-based resources which they generate and integrate. Extracting technological benefits during and after acquisition is ever challenging issue because of organizational differences. Based on the content analysis of seven interviews authors concluded five following components for their grounded model of acquisition:

Improper documentation and changing implicit knowledge makes it difficult to share information during acquisition.
For acquired firm symbolic and cultural independence which is the base of technology and capabilities are more important than administrative independence.
Detailed knowledge exchange and integrations are difficult when the acquired firm is large and high performing.
Management of executives from acquired firm is critical in terms of promotions and pay incentives to utilize their talent and value their expertise.
Transfer of technologies and capabilities are most difficult task to manage because of complications of acquisition implementation. The risk of losing implicit knowledge is always associated with the fast pace acquisition.

Preservation of tacit knowledge, employees and literature are always delicate during and after acquisition. Strategic management of all these resources is a very important factor for a successful acquisition.

Increase in acquisitions in our global business environment has pushed us to evaluate the key stake holders of acquisition very carefully before implementation. It is imperative for the acquirer to understand this relationship and apply it to its advantage. Retention is only possible when resources are exchanged and managed without affecting their independence.

Distinction between mergers and acquisitions

Although often used synonymously, the terms merger and acquisition mean slightly different things.This paragraph does not make a clear distinction between the legal concept of a merger (with the resulting corporate mechanics, statutory merger or statutory consolidation, which have nothing to do with the resulting power grab as between the management of the target and the acquirer) and the business point of view of a "merger", which can be achieved independently of the corporate mechanics through various means such as "triangular merger", statutory merger, acquisition, etc. When one company takes over another and clearly establishes itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded.

In the pure sense of the term, a merger happens when two firms agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals". The firms are often of about the same size. Both companies' stocks are surrendered and new company stock is issued in its place.For example, in the 1999 merger of Glaxo Wellcome and SmithKline Beecham, both firms ceased to exist when they merged, and a new company, GlaxoSmithKline, was created. In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it is technically an acquisition. Being bought out often carries negative connotations; therefore, by describing the deal euphemistically as a merger, deal makers and top managers try to make the takeover more palatable. An example of this would be the takeover of Chrysler by Daimler-Benz in 1999 which was widely referred to as a merger at the time.

A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. But when the deal is unfriendly (that is, when the target company does not want to be purchased) it is always regarded as an acquisition.

Business valuation

The five most common ways to valuate a business are

asset valuation,
historical earnings valuation,
future maintainable earnings valuation,
relative valuation (comparable company & comparable transactions),
discounted cash flow (DCF) valuation

Professionals who valuate businesses generally do not use just one of these methods but a combination of some of them, as well as possibly others that are not mentioned above, in order to obtain a more accurate value. The information in the balance sheet or income statement is obtained by one of three accounting measures: a Notice to Reader, a Review Engagement or an Audit.

Accurate business valuation is one of the most important aspects of M&A as valuations like these will have a major impact on the price that a business will be sold for. Most often this information is expressed in a Letter of Opinion of Value (LOV) when the business is being valuated for interest's sake. There are other, more detailed ways of expressing the value of a business. While these reports generally get more detailed and expensive as the size of a company increases, this is not always the case as there are many complicated industries which require more attention to detail, regardless of size.

Financing M&A

Mergers are generally differentiated from acquisitions partly by the way in which they are financed and partly by the relative size of the companies. Various methods of financing an M&A deal exist:

Cash

Payment by cash. Such transactions are usually termed acquisitions rather than mergers because the shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidder's shareholders.

Stock

Payment in the form of the acquiring company's stock, issued to the shareholders of the acquired company at a given ratio proportional to the valuation of the latter.

Which method of financing to choose?

There are some elements to think about when choosing the form of payment. When submitting an offer, the acquiring firm should consider other potential bidders and think strategically. The form of payment might be decisive for the seller. With pure cash deals, there is no doubt on the real value of the bid (without considering an eventual earnout). The contingency of the share payment is indeed removed. Thus, a cash offer preempts competitors better than securities. Taxes are a second element to consider and should be evaluated with the counsel of competent tax and accounting advisers. Third, with a share deal the buyer’s capital structure might be affected and the control of the buyer modified. If the issuance of shares is necessary, shareholders of the acquiring company might prevent such capital increase at the general meeting of shareholders. The risk is removed with a cash transaction. Then, the balance sheet of the buyer will be modified and the decision maker should take into account the effects on the reported financial results. For example, in a pure cash deal (financed from the company’s current account), liquidity ratios might decrease. On the other hand, in a pure stock for stock transaction (financed from the issuance of new shares), the company might show lower profitability ratios (e.g. ROA). However, economic dilution must prevail towards accounting dilution when making the choice. The form of payment and financing options are tightly linked. If the buyer pays cash, there are three main financing options:

Cash on hand: it consumes financial slack (excess cash or unused debt capacity) and may decrease debt rating. There are no major transaction costs.
It consumes financial slack, may decrease debt rating and increase cost of debt. Transaction costs include underwriting or closing costs of 1% to 3% of the face value.
Issue of stock: it increases financial slack, may improve debt rating and reduce cost of debt. Transaction costs include fees for preparation of a proxy statement, an extraordinary shareholder meeting and registration.

If the buyer pays with stock, the financing possibilities are:

Issue of stock (same effects and transaction costs as described above).
Shares in treasury: it increases financial slack (if they don’t have to be repurchased on the market), may improve debt rating and reduce cost of debt. Transaction costs include brokerage fees if shares are repurchased in the market otherwise there are no major costs.

In general, stock will create financial flexibility. Transaction costs must also be considered but tend to have a greater impact on the payment decision for larger transactions. Finally, paying cash or with shares is a way to signal value to the other party, e.g.: buyers tend to offer stock when they believe their shares are overvalued and cash when undervalued.^[5]

Specialist M&A advisory firms

Although at present the majority of M&A advice is provided by full-service investment banks, recent years have seen a rise in the prominence of specialist M&A advisers, who only provide M&A advice (and not financing). These companies are sometimes referred to as Transition companies, assisting businesses often referred to as "companies in transition." To perform these services in the US, an advisor must be a licensed broker dealer, and subject to SEC (FINRA) regulation. More information on M&A advisory firms is provided at corporate advisory.

Motives behind M&A

The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance:

Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
Economy of scope: This refers to the efficiencies primarily associated with demand-side changes, such as increasing or decreasing the scope of marketing and distribution, of different types of products.
Increased revenue or market share: This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices.
Cross-selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.
Synergy: For example, managerial economies such as the increased opportunity of managerial specialization. Another example are purchasing economies due to increased order size and associated bulk-buying discounts.
Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an acquiring company.
Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders (see below).
Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.^[6]
Vertical integration: Vertical integration occurs when an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur. One reason is to internalise an externality problem. A common example of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power and each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses. Following a merger, the vertically integrated firm can collect one deadweight loss by setting the downstream firm's output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable.^[7]
Hiring: some companies use acquisitions as an alternative to the normal hiring process. This is especially common when the target is a small private company or is in the startup phase. In this case, the acquiring company simply hires the staff of the target private company, thereby acquiring its talent (if that is its main asset and appeal). The target private company simply dissolves and little legal issues are involved.^{[citation needed]}
Absorption of similar businesses under single management: similar portfolio invested by two different mutual funds (Ahsan Raza Khan, 2009) namely united money market fund and united growth and income fund, caused the management to absorb united money market fund into united growth and income fund.</ref>

However, on average and across the most commonly studied variables, acquiring firms' financial performance does not positively change as a function of their acquisition activity.^[8] Therefore, additional motives for merger and acquisition that may not add shareholder value include:

Diversification: While this may hedge a company against a downturn in an individual industry it fails to deliver value, since it is possible for individual shareholders to achieve the same hedge by diversifying their portfolios at a much lower cost than those associated with a merger. (In his book One Up on Wall Street, Peter Lynch memorably termed this "diworseification".)
Manager's hubris: manager's overconfidence about expected synergies from M&A which results in overpayment for the target company.
Empire-building: Managers have larger companies to manage and hence more power.
Manager's compensation: In the past, certain executive management teams had their payout based on the total amount of profit of the company, instead of the profit per share, which would give the team a perverse incentive to buy companies to increase the total profit while decreasing the profit per share (which hurts the owners of the company, the shareholders)..

Effects on management

Merger & Acquisitions (M&A) term explains the corporate strategy which determines the financial and long term effects of combination of two companies to create synergies or divide the existing company to gain competitive ground for independent units. A study published in the July/August 2008 issue of the Journal of Business Strategy suggests that mergers and acquisitions destroy leadership continuity in target companies’ top management teams for at least a decade following a deal. The study found that target companies lose 21 percent of their executives each year for at least 10 years following an acquisition – more than double the turnover experienced in non-merged firms.^[9] If the businesses of the acquired and acquiring companies overlap, then such turnover is to be expected; in other words, there can only be one CEO, CFO, et cetera at a time.

Different Types of M&A

The M&A process itself is a multifaceted which depends upon the type of merging companies.

- A horizontal merger is usually between two companies in the same business sector. The example of horizontal merger would be if a health cares system buys another health care system. This means that synergy can obtained through many forms including such as; increased market share, cost savings and exploring new market opportunities. - A vertical merger represents the buying of supplier of a business. In the same example as above if a health care system buys the ambulance services from their service suppliers is an example of vertical buying. The vertical buying is aimed at reducing overhead cost of operations and economy of scale. - Conglomerate M&A is the third form of M&A process which deals the merger between two irrelevant companies. The example of conglomerate M&A with relevance to above scenario would be if health care system buys a restaurant chain. The objective may be diversification of capital investment.

An arm's length merger is a merger: 1. approved by disinterested directors and 2. approved by disinterested stockholders:

″The two elements are complementary and not substitutes. The first element is important because the directors have the capability to act as effective and active bargaining agents, which disaggregated stockholders do not. But, because bargaining agents are not always effective or faithful, the second element is critical, because it gives the minority stockholders the opportunity to reject their agents' work. Therefore, when a merger with a controlling stockholder was: 1) negotiated and approved by a special committee of independent directors; and 2) conditioned on an affirmative vote of a majority of the minority stockholders, the business judgment standard of review should presumptively apply, and any plaintiff ought to have to plead particularized facts that, if true, support an inference that, despite the facially fair process, the merger was tainted because of fiduciary wrongdoing.″^[10]

Strategic Mergers

A Strategic merger usually refers to long term strategic holding of target (Acquired) firm. This type of M&A process aims at creating synergies in the long run by increased market share, broad customer base, and corporate strength of business. A strategic acquirer may also be willing to pay a premium offer to target firm in the outlook of the synergy value created after M&A process.

M&A research and statistics for acquired organizations

Given that the cost of replacing an executive can run over 100% of his or her annual salary, any investment of time and energy in re-recruitment will likely pay for itself many times over if it helps a business retain just a handful of key players that would have otherwise left.^[11]

Organizations should move rapidly to re-recruit key managers. It’s much easier to succeed with a team of quality players that you select deliberately rather than try to win a game with those who randomly show up to play.^[12]

Brand considerations

Mergers and acquisitions often create brand problems, beginning with what to call the company after the transaction and going down into detail about what to do about overlapping and competing product brands. Decisions about what brand equity to write off are not inconsequential. And, given the ability for the right brand choices to drive preference and earn a price premium, the future success of a merger or acquisition depends on making wise brand choices. Brand decision-makers essentially can choose from four different approaches to dealing with naming issues, each with specific pros and cons:^[13]

Keep one name and discontinue the other. The strongest legacy brand with the best prospects for the future lives on. In the merger of United Airlines and Continental Airlines, the United brand will continue forward, while Continental is retired.
Keep one name and demote the other. The strongest name becomes the company name and the weaker one is demoted to a divisional brand or product brand. An example is Caterpillar Inc. keeping the Bucyrus International name.^[14]
Keep both names and use them together. Some companies try to please everyone and keep the value of both brands by using them together. This can create a unwieldy name, as in the case of PricewaterhouseCoopers, which has since changed its brand name to "PwC".
Discard both legacy names and adopt a totally new one. The classic example is the merger of Bell Atlantic with GTE, which became Verizon Communications. Not every merger with a new name is successful. By consolidating into YRC Worldwide, the company lost the considerable value of both Yellow Freight and Roadway Corp.

The factors influencing brand decisions in a merger or acquisition transaction can range from political to tactical. Ego can drive choice just as well as rational factors such as brand value and costs involved with changing brands.^[14]

Beyond the bigger issue of what to call the company after the transaction comes the ongoing detailed choices about what divisional, product and service brands to keep. The detailed decisions about the brand portfolio are covered under the topic brand architecture.

The Great Merger Movement

The Great Merger Movement was a predominantly U.S. business phenomenon that happened from 1895 to 1905. During this time, small firms with little market share consolidated with similar firms to form large, powerful institutions that dominated their markets. It is estimated that more than 1,800 of these firms disappeared into consolidations, many of which acquired substantial shares of the markets in which they operated. The vehicle used were so-called trusts. In 1900 the value of firms acquired in mergers was 20% of GDP. In 1990 the value was only 3% and from 1998–2000 it was around 10–11% of GDP. Companies such as DuPont, US Steel, and General Electric that merged during the Great Merger Movement were able to keep their dominance in their respective sectors through 1929, and in some cases today, due to growing technological advances of their products, patents, and brand recognition by their customers. There were also other companies that held the greatest market share in 1905 but at the same time did not have the competitive advantages of the companies like DuPont and General Electric. These companies such as International Paper and American Chicle saw their market share decrease significantly by 1929 as smaller competitors joined forces with each other and provided much more competition. The companies that merged were mass producers of homogeneous goods that could exploit the efficiencies of large volume production. In addition, many of these mergers were capital-intensive. Due to high fixed costs, when demand fell, these newly-merged companies had an incentive to maintain output and reduce prices. However more often than not mergers were "quick mergers". These "quick mergers" involved mergers of companies with unrelated technology and different management. As a result, the efficiency gains associated with mergers were not present. The new and bigger company would actually face higher costs than competitors because of these technological and managerial differences. Thus, the mergers were not done to see large efficiency gains, they were in fact done because that was the trend at the time. Companies which had specific fine products, like fine writing paper, earned their profits on high margin rather than volume and took no part in Great Merger Movement.^{[citation needed]}

Short-run factors

One of the major short run factors that sparked The Great Merger Movement was the desire to keep prices high. However, high prices attracted the entry of new firms into the industry who sought to take a piece of the total product. With many firms in a market, supply of the product remains high.

A major catalyst behind the Great Merger Movement was the Panic of 1893, which led to a major decline in demand for many homogeneous goods. For producers of homogeneous goods, when demand falls, these producers have more of an incentive to maintain output and cut prices, in order to spread out the high fixed costs these producers faced (i.e. lowering cost per unit) and the desire to exploit efficiencies of maximum volume production. However, during the Panic of 1893, the fall in demand led to a steep fall in prices.

Another economic model proposed by Naomi R. Lamoreaux for explaining the steep price falls is to view the involved firms acting as monopolies in their respective markets. As quasi-monopolists, firms set quantity where marginal cost equals marginal revenue and price where this quantity intersects demand. When the Panic of 1893 hit, demand fell and along with demand, the firm’s marginal revenue fell as well. Given high fixed costs, the new price was below average total cost, resulting in a loss. However, also being in a high fixed costs industry, these costs can be spread out through greater production (i.e. Higher quantity produced). To return to the quasi-monopoly model, in order for a firm to earn profit, firms would steal part of another firm’s market share by dropping their price slightly and producing to the point where higher quantity and lower price exceeded their average total cost. As other firms joined this practice, prices began falling everywhere and a price war ensued.^[15]

One strategy to keep prices high and to maintain profitability was for producers of the same good to collude with each other and form associations, also known as cartels. These cartels were thus able to raise prices right away, sometimes more than doubling prices. However, these prices set by cartels only provided a short-term solution because cartel members would cheat on each other by setting a lower price than the price set by the cartel. Also, the high price set by the cartel would encourage new firms to enter the industry and offer competitive pricing, causing prices to fall once again. As a result, these cartels did not succeed in maintaining high prices for a period of no more than a few years. The most viable solution to this problem was for firms to merge, through horizontal integration, with other top firms in the market in order to control a large market share and thus successfully set a higher price.^{[citation needed]}

Long-run factors

In the long run, due to desire to keep costs low, it was advantageous for firms to merge and reduce their transportation costs thus producing and transporting from one location rather than various sites of different companies as in the past. Low transport costs, coupled with economies of scale also increased firm size by two- to fourfold during the second half of the nineteenth century. In addition, technological changes prior to the merger movement within companies increased the efficient size of plants with capital intensive assembly lines allowing for economies of scale. Thus improved technology and transportation were forerunners to the Great Merger Movement. In part due to competitors as mentioned above, and in part due to the government, however, many of these initially successful mergers were eventually dismantled. The U.S. government passed the Sherman Act in 1890, setting rules against price fixing and monopolies. Starting in the 1890s with such cases as Addyston Pipe and Steel Company v. United States, the courts attacked large companies for strategizing with others or within their own companies to maximize profits. Price fixing with competitors created a greater incentive for companies to unite and merge under one name so that they were not competitors anymore and technically not price fixing.

Merger waves

The economic history has been divided into Merger Waves based on the merger activities in the business world as:^[16]

Period	Name	Facet
1897–1904	First Wave	Horizontal mergers
1916–1929	Second Wave	Vertical mergers
1965–1969	Third Wave	Diversified conglomerate mergers
1981–1989	Fourth Wave	Congeneric mergers; Hostile takeovers; Corporate Raiding
1992–2000	Fifth Wave	Cross-border mergers
2003–2008	Sixth Wave	Shareholder Activism, Private Equity, LBO

Deal objectives in more recent merger waves

During the third merger wave (1965–1989), corporate marriages involved more diverse companies. Acquirers more frequently bought into different industries. Sometimes this was done to smooth out cyclical bumps, to diversify, the hope being that it would hedge an investment portfolio.

Starting in the fourth merger wave (1992–1998) and continuing today, companies are more likely to acquire in the same business, or close to it, firms that complement and strengthen an acquirer’s capacity to serve customers.

Buyers aren’t necessarily hungry for the target companies’ hard assets. Some are more interested in acquiring thoughts, methodologies, people and relationships. Paul Graham recognized this in his 2005 essay "Hiring is Obsolete", in which he theorizes that the free market is better at identifying talent, and that traditional hiring practices do not follow the principles of free market because they depend a lot upon credentials and university degrees. Graham was probably the first to identify the trend in which large companies such as Google, Yahoo or Microsoft were choosing to acquire startups instead of hiring new recruits.^[17]

Many companies are being bought for their patents, licenses, market share, name brand, research staffs, methods, customer base, or culture. Soft capital, like this, is very perishable, fragile, and fluid. Integrating it usually takes more finesse and expertise than integrating machinery, real estate, inventory and other tangibles.^[18]

Cross-border M&A

In a study conducted in 2000 by Lehman Brothers, it was found that, on average, large M&A deals cause the domestic currency of the target corporation to appreciate by 1% relative to the acquirers.

The rise of globalization has exponentially increased the necessity for MAIC Trust accounts and securities clearing services for Like-Kind Exchanges for cross-border M&A. In 1997 alone, there were over 2333 cross-border transactions, worth a total of approximately $298 billion. Due to the complicated nature of cross-border M&A, the vast majority of cross-border actions have unsuccessful anies seek to expand their global footprint and become more agile at creating high-performing businesses and cultures across national boundaries.^[19]

Even mergers of companies with headquarters in the same country are very much of this type and require MAIC custodial services (cross-border Mergers). After all, when Boeing acquires McDonnell Douglas, the two American companies must integrate operations in dozens of countries around the world. This is just as true for other supposedly "single country" mergers, such as the $29 billion dollar merger of Swiss drug makers Sandoz and Ciba-Geigy (now Novartis).

M&A failure

Despite the goal of performance improvement, results from mergers and acquisitions (M&A) are often disappointing. Numerous empirical studies show high failure rates of M&A deals. Studies are mostly focused on individual determinants. A book by Thomas Straub (2007) "Reasons for frequent failure in Mergers and Acquisitions"^[20] develops a comprehensive research framework that bridges different perspectives and promotes a modern understanding of factors underlying M&A performance. The first important step towards this objective is the development of a common frame of reference that spans conflicting theoretical assumptions from different perspectives. On this basis, a comprehensive framework is proposed with which to understand the origins of M&A performance better and address the problem of fragmentation by integrating the most important competing perspectives in respect of studies on M&A Furthermore according to the existing literature relevant determinants of firm performance are derived from each dimension of the model. For the dimension strategic management, the six strategic variables: market similarity, market complementarities, production operation similarity, production operation complementarities, market power, and purchasing power were identified having an important impact on M&A performance. For the dimension organizational behavior, the variables acquisition experience, relative size, and cultural differences were found to be important. Finally, relevant determinants of M&A performance from the financial field were acquisition premium, bidding process, and due diligence. Three different ways in order to best measure post M&A performance are recognized: Synergy realization, absolute performance and finally relative performance.

Turnover contributes to M&A failures. The turnover in target companies is double the turnover experienced in non-merged firms for the ten years following the merger.^[21]

Major M&A

1990s

Top 10 M&A deals worldwide by value (in mil. USD) from 1990 to 1999^[22]:

Rank	Year	Purchaser	Purchased	Transaction value (in mil. USD)
1	1999	Vodafone Airtouch PLC^[23]	Mannesmann	183,000
2	1999	Pfizer^[24]	Warner-Lambert	90,000
3	1998	Exxon^[25]^[26]	Mobil	77,200
4	1998	Citicorp	Travelers Group	73,000
5	1999	SBC Communications	Ameritech Corporation	63,000
6	1999	Vodafone Group	AirTouch Communications	60,000
7	1998	Bell Atlantic^[27]	GTE	53,360
8	1998	BP^[28]	Amoco	53,000
9	1999	Qwest Communications	US WEST	48,000
10	1997	Worldcom	MCI Communications	42,000

2000s

Top 10 M&A deals worldwide by value (in mil. USD) from 2000 to 2010^[22]:

Rank	Year	Purchaser	Purchased	Transaction value (in mil. USD)
1	2000	Fusion: AOL Inc. (America Online)^[29]^[30]	Time Warner	164,747
2	2000	Glaxo Wellcome Plc.	SmithKline Beecham Plc.	75,961
3	2004	Royal Dutch Petroleum Company	"Shell" Transport & Trading Co.	74,559
4	2006	AT&T Inc.^[31]^[32]	BellSouth Corporation	72,671
5	2001	Comcast Corporation	AT&T Broadband	72,041
6	2009	Pfizer Inc.	Wyeth	68,000
7	2000	Spin-off: Nortel Networks Corporation		59,974
8	2002	Pfizer Inc.	Pharmacia Corporation	59,515
9	2004	JPMorgan Chase & Co.^[33]	Bank One Corporation	58,761
10	2008	InBev Inc.	Anheuser-Busch Companies, Inc.	52,000

M&A in popular culture

In the novel American Psycho the protagonist Patrick Bateman, played by Christian Bale in the film adaptation, works in mergers and acquisitions, which he once referred to as "murders and executions" to a potential victim.

In the film The Thomas Crown Affair, Thomas Crown is the CEO of a fictional mergers and acquisitions firm, called Crown Acquisitions.

References

^ {Investment banking explained pp.223,224
^ "Mergers and acquisitions explained". http://www.m-and-a-explained.com/. Retrieved 2009-06-30.
^ Harwood, 2005
^ Reverse Merger in the glossary of mergers-acquisitions.org
^ mergers.acquisitions.ch
^ King, D. R.; Slotegraaf, R.; Kesner, I. (2008). "Performance implications of firm resource interactions in the acquisition of R&D-intensive firms". Organization Science 19 (2): 327–340. doi:10.1287/orsc.1070.0313.
^ Maddigan, Ruth; Zaima, Janis (1985). "The Profitability of Vertical Integration". Managerial and Decision Economics 6 (3): 178–179. doi:10.1002/mde.4090060310.
^ King, D. R.; Dalton, D. R.; Daily, C. M.; Covin, J. G. (2004). "Meta-analyses of Post-acquisition Performance: Indications of Unidentified Moderators". Strategic Management Journal 25 (2): 187–200. doi:10.1002/smj.371.
^ Mergers and Acquisitions Lead to Long-Term Management Turmoil Newswise, Retrieved on July 14, 2008.
^ In re Cox Communications, Inc. Shareholders Litig., 879 A.2d 604, 606 (Del. Ch. 2005).
^ "M&A Research and Statistics for Acquired Organizations" MergerIntegration.com
^ "The Right Human Resources Approach to M&A Turnover" MergerIntegration.com
^ http://merriamassociates.com/2010/10/newsbeast-and-other-merger-name-options/
^ ^a ^b http://merriamassociates.com/2010/11/caterpillar%E2%80%99s-new-legs%E2%80%94acquiring-the-bucyrus-international-brand/
^ Lamoreaux, Naomi R. “The great merger movement in American business, 1895-1904.” Cambridge University Press, 1985.
^ http://osgoode.yorku.ca/media2.nsf/58912001c091cdc8852569300055bbf9/1e37719232517fd0852571ef00701385/$file/merger%20waves_toronto_lipton.pdf
^ paulgraham.com
^ “Mergers: New Game, New Goals” MergerIntegration.com
^ M&A Agility for Global Organizations
^ [Straub, Thomas (2007). Reasons for frequent failure in Mergers and Acquisitions: A comprehensive analysis. Wiesbaden: Deutscher Universitäts-Verlag (DUV), Gabler Edition Wissenschaft. ISBN 978-3-8350-0844-1. ]
^ "Acquired Companies Prior to Close" MergerIntegration.com
^ ^a ^b [1]
^ "Mannesmann to accept bid - February 3, 2000". CNN. February 3, 2000. http://money.cnn.com/2000/02/03/europe/vodafone/.
^ Pfizer and Warner-Lambert agree to $90 billion merger creating the world's fastest-growing major pharmaceutical company
^ "Exxon, Mobil mate for $80B - December 1, 1998". CNN. December 1, 1998. http://money.cnn.com/1998/12/01/deals/exxon/.
^ Finance: Exxon-Mobil Merger Could Poison The Well
^ Fool.com: Bell Atlantic and GTE Agree to Merge (Feature) July 28, 1998
^ http://www.eia.doe.gov/emeu/finance/fdi/ad2000.html
^ Online NewsHour: AOL/Time Warner Merger
^ "AOL and Time Warner to merge - January 10, 2000". CNN. January 10, 2000. http://money.cnn.com/2000/01/10/deals/aol_warner/.
^ "AT&T To Buy BellSouth For $67 Billion". CBS News. March 5, 2006. http://www.cbsnews.com/stories/2006/03/05/business/main1369428.shtml.
^ AT&T- News Room
^ "J. P. Morgan to buy Bank One for $58 billion". CNNMoney.com. 2004-01-15. http://money.cnn.com/2004/01/14/news/deals/jpmorgan_bankone/.

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Mergers and acquisitions

Mergers and Acquisitions

Mergers and Acquisitions

Mergers and Acquisitions

Mergers And Acquisitions - M&A

Mergers and acquisitions

Acquisition

Distinction between mergers and acquisitions

Business valuation

Financing M&A

Cash

Stock

Which method of financing to choose?

Specialist M&A advisory firms

Motives behind M&A

Effects on management

Different Types of M&A

Strategic Mergers

M&A research and statistics for acquired organizations

Brand considerations

The Great Merger Movement

Short-run factors

Long-run factors

Merger waves

Deal objectives in more recent merger waves

Cross-border M&A

M&A failure

Major M&A

1990s

2000s

M&A in popular culture

See also

References

Further reading

	investment bank
	Crown Jewels (business term)
	Earn-Out (business term)

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