In general, mergers and acquisitions (or takeovers) are very similar corporate actions. They merge two previously independent businesses into a single legal entity. When two companies merge, they can gain significant operational advantages. The goal of most mergers and acquisitions is to improve company performance and shareholder value in the long run.
The incentive to pursue a merger or acquisition can be substantial. A company that merges with another can benefit from:
- Increased economies of scale
- Increased sales revenue
- Increased market share
- Broader diversification
- Bigger tax efficiency
The underlying business rationale and financing methodology for mergers and acquisitions differ significantly. In this article, we will discuss the broad differences between a merger and an acquisition.
What is a merger?
A merger is the mutual decision of two businesses to merge and form one entity. It can be viewed as a decision made by two “equals” in the industry. They can be two different businesses and their merger will extend the business offerings. Because of the structural and operational advantages secured by the merger, the combined business can:
- Cut costs
- Increase profits
- Increase shareholder value for both groups of shareholders
In other words, a typical merger involves two relatively equal companies combining to form one legal entity. It produces a company that is worth more than the sum of its parts. When two corporations merge, the shareholders’ shares in the old company are usually exchanged for an equal number of shares in the merged entity.
For instance, in 1998, the American automaker Chrysler Corp. merged with the world-known German automaker company Daimler Benz and formed DaimlerChrysler. As chairmen of both organizations became joint leaders in the new organization, this had all the hallmarks of a merger of equals. The merger was thought to be beneficial to both companies. It allowed Chrysler to expand into European markets and gave Daimler Benz a stronger presence in North America.
What is a takeover?
A takeover, on the other hand, is defined as the purchase of a smaller company by a much larger one. This is a combination of “unequal” companies. It can derive the same value as a merger. Although it may not be a mutual decision. A takeover can be of two kinds:
- Friendly Takeover: A friendly takeover occurs when the board of directors of both the target and the acquirer reaches an agreement and consent to the T&C of the takeover agreement. In this case, shareholders are also allowed to vote for or against the takeover. An example of a friendly takeover would be the Walt Disney Corporation’s 2006 purchase of Pixar Animation Studios where Pixar’s shareholders unanimously approved the acquisition decision
- Hostile Takeover: In a hostile takeover the acquirer company takeovers the target company forcefully. There can be two scenarios:
- The target company does not want to be acquired or merged.
- The target company’s board of directors considers the bid to be unacceptable or too low, undermining the target company’s potential and prestige.
In both scenarios, if the acquirer company still wishes to take over the target company, this is referred to as a hostile takeover. A larger company can launch a hostile takeover of a smaller firm. It essentially buys the company despite opposition from the smaller company’s management. You will observe two contrasting situations in a takeover vis-a-vis a merger:
- The acquiring firm offers a cash price for every share of the target firm to its shareholders
- The acquiring firm offers its shares to the target firm’s shareholders based on a specified conversion ratio.
Conclusion
Stock purchases and exchanges can be used to fund mergers and takeovers. This is the most used type of financing. In other cases, cash or a combination of cash and equity can be used. In some cases, debt can be used to fund a leveraged buyout, which is most common in a takeover.