The idea of “mergers and acquisitions” or “M&A” can be a bit of a misnomer. Mergers are different and, frankly, less common than acquisitions, and acquisitions can be further split into asset sales and equity sales.
Why engage in a Merger or Acquisition?
A company might consider acquiring another company for many reasons, including gaining market share, vertical integration, removing competition, and diversification. When considering acquiring or merging with another company, it is essential to consider whether the transaction will help you and your business accomplish your goals. Some questions to consider when thinking of engaging in an M&A transaction:
- What makes this transaction essential?
- Is there a specific opportunity, market, or goal?
- How would not engaging in this transaction affect your business?
- Does this transaction fit in with your company’s growth strategy?
- What is the market size? How much market share does the other party hold?
- Will this transaction prevent other growth options?
- How will you pay for the transaction?
- If the deal is to be all cash, can you afford that?
- Is financing available for the transaction? Are the repayments within your budget?
- Why is the other party selling?
- What’s their reputation in the industry?
- Is the business profitable?
What is an Acquisition?
An acquisition occurs when a company (the “Buyer”) purchases the assets or equity of another company (the “Seller” or “Target”). Typically, the Buyer will acquire substantially all of the assets or a controlling interest in the Seller. However, partial asset and minority interest equity acquisitions do occur. Assuming the Buyer wishes to acquire a controlling interest via an equity purchase, it must purchase a voting majority of the Seller’s stock or units. Most often, this means buying at least 51%. However, Buyers should check whether the Target has any super majority voting requirements. In such cases, the Buyer may need to hold 75% or more of the voting stock or units to truly hold a controlling interest. Further, there may be different classes of stock or units, each with its own voting powers to consider. Buyers should conduct thorough due diligence to truly understand these types of issues.
What motivates Buyers? What are the potential benefits of acquiring another company?
- Horizontal Acquisitions allow Buyers to expand the areas where they offer goods and services. Typically, in horizontal acquisitions, Buyer and Seller operate in the same industry, offering the same products or services.
Example: Company A, a manufacturer of products in Pittsburgh, Pennsylvania, acquires Company B, which produces the same products in Sacramento, California. The acquisition allows Company A to reach a new consumer base in California without starting a new branch from scratch.
- Vertical Acquisitions help Buyers to achieve new efficiencies, such as when a Buyer acquires a Seller that operates at a different position in the same supply chain.
Example: Company A, a manufacturer of products, acquires Company B, which manufactures a key component of the products produced by Company A. Company A can now source the key component internally and avoid paying a markup to a third-party vendor.
- Conglomerate Acquisitions allow Buyers to broaden the scope of their goods and services by buying a Seller in an unrelated industry.
Example: Company A, a book publisher, acquires Company B, a stationary company. Company A can now offer a new suite of products to its customers.
- Congeneric Acquisitions allow Buyers to add to the services or products they offer their customers.
Example: Company A, a computer manufacturer, acquires Company B, a monitor manufacturer. Think of this as the “now sold together” acquisition. Company A can bundle the computer with the monitor going forward.
What is a Merger?
Generally, a merger is when two or more business entities combine and transfer all their assets and liabilities into a single entity. However, this definition leaves out the nuance of how this combination occurs.
In a “Consolidation Merger,” two or more business entities combine and contribute their assets and liabilities to a new entity. Think of this as Entity 1 + Entity 2 = Entity 3. Once the merger goes through, the stock and unit holders in Entity 1 and Entity 2 will end up with stock or units in Entity 3.
In a “Share Exchange Merger” or “Stock for Stock Merger,” one entity is absorbed by the other. This second example differs from an equity acquisition because the Buyer is not merely purchasing the Seller’s stock or units. Instead, the stock or unit holders in the entity being absorbed consent to replacing their stock or units with those of the entity remaining. Think of this as Entity 1 + Entity 2 = Entity 2 (and all the Entity 1 stock and unit holders now own equivalent Entity 2 stock or units.) This type of merger has other variations, such as when both entities remain active post-closing, but one becomes a subsidiary.
“Triangular Mergers” involve a parent company (the “Parent”), a subsidiary of the parent company (“Subsidiary”), and an unrelated entity the Parent wishes to acquire (the “Target”). Triangular Mergers complete the acquisition of the Target through a merger between the Target and the Subsidiary. Sometimes, the Subsidiary is newly formed by the Parent to acquire the Target. Triangular Mergers are divided into Forward Triangular Mergers, where the Target merges into the Subsidiary, and Reverse Triangular Mergers, where the Subsidiary merges into the Target. The main advantage of a Triangular Merger is that the Parent acquires the Target without assuming any of its liabilities.
Example 1: The Parent, Subsidiary, and Target are parties to a Forward Triangular Merger. At the end of the transaction, Target will merge into Subsidiary and cease to exist as an independent entity.
Example 2: Parent, Subsidiary, and Target are parties to a Reverse Triangular Merger. At the end of the transaction, Subsidiary will merge into the Target and cease to exist as an independent entity.
Generally, mergers start with drafting a merger plan, which must be adopted and approved by both entities’ manager(s) or board of directors and owners.
It is important to note that mergers are statutory transactions whose requirements are set out by the business entity laws of the Buyer and Seller’s state(s) of formation. The state statutes governing mergers lay out the requirements of the transaction, including, but not limited to, filing deadlines and deal document language. Additionally, if the entities in the merger are not a) from the same state and b) the same type of entity, then the transaction will have to comply with multiple statutes. These statutes may contradict or be inconsistent, increasing the time and expense required for the transaction.
If you have questions or want more information about Mergers and Acquisitions, please contact Penwell Law.
Sources:
- The different types and methods of mergers and acquisitions. https://www.wolterskluwer.com/en/expert-insights/the-different-types-and-methods-of-mergers-and-acquisitions
- What Are Mergers and Acquisitions (M&A)? https://www.investopedia.com/terms/m/mergersandacquisitions.asp
- Merger: Definition, How It Works With Types and Examples. https://www.investopedia.com/terms/m/merger.asp
