When most people hear that a company has acquired a certain brand or entity, all they see is the transaction price and the change in ownership. Most people don’t realize the complexity of the transaction, the level of detail involved and the strategy behind the acquisition.
In this article, we will go deeper into the meaning of M&A and why companies make M&A part of their growth strategy.
What Is M&A: Meaning, Definition, Examples
Mergers and acquisitions (M&A) is a term generally used to describe the process of combining companies through various types of transactions. The most popular is an acquisition, where one company buys another and transfers ownership. You can make two kinds of acquisitions; sale of shares and sale of assets.
A share sale is where a buyer purchases the entire business entity and everything related to it, including assets and liabilities. Legally, the business still owns the assets and liabilities, but the buyer is the new owner of the business. On the other hand, there is an asset sale, where the buyer buys a specific asset of the target business, such as equipment or intellectual property. In some cases, companies even sell an entire business segment, which is called a divestiture or spin-off.
Meanwhile, mergers are where two companies of the same size come together consensually to form a single entity. Mergers and acquisitions are often used interchangeably, but technically they have different meanings. More often than not, mergers tend to end up using one of the company’s names or brands, which ends up looking like a takeover or acquisition.
Why Do Companies Do M&A?
- It is not enough to know what mergers and acquisitions are, but it is also important to understand why companies make mergers and acquisitions part of their growth strategy. Have you ever wondered why Disney bought 21st Century Fox for $71 billion?
- M&A is a powerful tool that can transform your business overnight. The primary intention is to grow your company quickly without having to do much of the work. The basic idea is that the buyer will achieve greater return or reduce costs by acquiring the target company. This is commonly called synergy.
- Synergy means that the combination of two companies should exceed the value they bring as individual companies. The buyer is looking for 1+1=3. There are two types of synergies in mergers and acquisitions: cost synergy and revenue synergy.
- Cost synergies are cost reductions as a direct result of combining two companies. The most common example is achieving economies of scale. If you get a company that uses the same raw materials as you, you will be able to negotiate a lower price because you will be ordering more from your suppliers.
- On the other hand, revenue synergies are the ability to generate more revenue as a combined company. For example, say a clothing manufacturer acquires a shoe manufacturer. The buyer’s clients will now buy shoes from them, while the shoe company’s existing clients will also start buying clothes from them.
- Strategically, there are three main reasons why companies go through acquisitions; expansion, defensive play and skill acquisition.
- The most common reason for an acquisition is to gain market share or geographical expansion and product diversification. An excellent example of this is when Apple decided to acquire Beats in 2014. Before this acquisition, Apple had never sold headphones, but they were working on one at the time. Beats generated a lot of revenue and had an impressive following. By acquiring Beats, they gained product diversification and gained Beat’s market share for future headphones.
- Another reason for acquiring a company is defensive reasons. Buying a competitor means that you can strengthen the company’s position in the market and eliminate future threats. A perfect example of this was when Facebook bought WhatsApp in 2014. WhatsApp was an emerging threat to Facebook that could topple it in some markets. Facebook bought WhatsApp to eliminate competition, while WhatsApp was able to walk away with a big fat check.
- Finally, capability acquisitions are when a company acquires technology or talent that it does not have and cannot build, but that it can use better than the target company. Creating from scratch will take time and money, and you will lose market opportunities at the same time. At this point, buying the ability would be more profitable.
- However, this does not mean that all acquisitions are success stories. A bad acquisition could also change your business overnight, just in the wrong direction. Spending a lot of money on an acquisition with no return on investment can be devastating to your business.
- An example of this is the acquisition of Skype by eBay. The idea was that the integration of the two companies would enable communication between buyers and sellers on eBay, facilitate the flow of transactions and generate more revenue. eBay didn’t anticipate that people wouldn’t want to talk to strangers about transactions if they could simply email them. eBay soon realized that the acquisition wasn’t really needed and ended up selling two-thirds of Skype just four years later.
- In short, companies conduct mergers and acquisitions to rapidly increase the growth of their company by gaining an advantage that they would not normally have without the other company. This is probably the only case where 1+1=3. All of these should be considered as part of a company’s M&A strategy before starting any M&A processes.
Other Types Of Transactions
M&A is not all about buying and selling. If neither party wants to give up ownership, other transactions can be made to increase the growth rate; such as joint ventures, partnerships and alliances. There are very fine lines separating these types of agreements. Legally, however, they make all the difference in the world.
Joint Ventures
Joint ventures are mutual agreements that involve individuals, but more commonly occur between entities and organizations pooling their resources together to form a new entity with the sole purpose of achieving a specific goal. An example of this was in 2011 when Ford Motors and Toyota Motors agreed to develop new hybrid systems for use in light trucks. At the time, Toyota was the world leader in hybrid technology, while Ford was the market leader in pickup trucks and SUVs. Both parties would learn from this joint venture and integrate the hybrid systems independently.
In this example, both parties had a common goal. But that doesn’t always have to be the case. In some cases, the parties will have a different agenda, but both parties will still benefit from the deal. Depending on the scope of their contract, once they reach the goal, the joint venture will dissolve.
Strategic Alliances
Alliances are very similar to joint ventures with a few differences. Although the two sides have agreed to help each other by sharing their resources, they do not form a separate entity. They have no formal agreement at all. Alliances are usually formed through a handshake and nothing more.
Since they do not form a separate entity, they also do not physically work together as joint ventures. These parties work together but operate separately and independently from each other. The management and administration of the alliance is usually delegated to an existing employee.
Partner Relationships
The intent and structure of partnerships are very different from joint ventures and strategic alliances. In a partnership, two or more separate individuals agree to create a new legal entity to run the entire business (within the partnership). Unlike joint ventures and alliances, the agreement is not limited to a specific task or objective. Their contract or partnership agreement is aimed at running a long-term profitable business with no time limit.
When To M&A?
- To put it simply, there are two types of acquirers: proactive buyers and reactive buyers.
- It is not unusual for large public companies to constantly look for growth opportunities. They are proactive buyers who are constantly looking for opportunities to acquire companies to achieve inorganic growth. These companies are usually sitting on a large pile of cash and use mergers and acquisitions as a large part of their strategy.
- The basic tenet of acquisition is that when a technology or idea emerges, it will likely take months or years to develop and realize the full potential of that particular opportunity. Not only are you missing out on current market opportunities, but there is always the risk that you will not be able to make the deal last. If an existing entity offers the same capability or product you’re aiming for, it’s probably best to buy the entity rather than develop it yourself.
- Opportunities can also appear out of nowhere. We call these reactive buyers who come across an opportunity to buy a company. Sellers may suddenly decide to sell their company for various reasons, which can be a good acquisition for the buyer’s company.
- Usually, when a private company decides to sell its business, the owner is ready to retire and move away from the company. They could also be serial entrepreneurs moving on to their next venture. Either way, it will make the buyer react and consider buying the business.
Conclusion
So what is M&A? It’s more than just buying and selling a company. Every transaction involves a lot of strategy and complexity. Each of the above transactions is done to transform the company for the better. If you want to know what goes on behind the scenes of an M&A transaction, be sure to subscribe to our podcast
