Merger Acquisition (M&A)
Merger acquisition is also called “M&A” for “Mergers and Acquisition”. It defines a legal transaction consisting in transferring the assets of one company to another company. The assets and liabilities of the absorbed company are transmitted to the absorbing company, implying a dissolution (without liquidation) and an exchange of social rights. The merger absorption is pure and simple where the two companies concerned form a single entity. Merger-acquisition is less strong, it aims at legal control and powers at general meetings. The operation leaves legal individuality to the two entities concerned.
The advantages and disadvantages of mergers and acquisitions show that this business transaction should not be something you rush into mindlessly. A decision with power is required. By evaluating all the key points, it is more likely that the best possible decision can be made.
Definition of merger-acquisition
A merger-acquisition constitutes the universal transfer of the assets of one company to another company. All of the assets and liabilities elements of the acquired company are transferred to the acquiring company.
The merger-acquisition involves:
- the dissolution (without liquidation) of the absorbed company
- an exchange of social rights
A merger is the union of two or more legally independent people who decide to pool their assets and form a new company. If one of the merging companies absorbs the assets of the remaining companies, we are dealing with a merger by absorption.
An acquisition consists of the purchase by a legal entity of the controlling shareholder package of another company, without merging its assets.
Examples of mergers and acquisitions
This type of legal operation is practiced to diversify the activity of the acquiring company, increase its presence on a market or on its value chain. Merger-acquisition is a restructuring of the activity and objectives of the absorbing company.
When a company absorbs the leader in its economic sector, it is known as vertical merger and acquisition. The objective for the acquiring company is to control its entire chain (for example, a milk distributor absorbs the leading milk manufacturer on the market).
When the company absorbs one or more complementary companies, we speak of horizontal mergers and acquisitions. The goal is to increase market share by offering diversified products/services in a sector (for example, a milk manufacturer and distributor takes over a yogurt manufacturing company to offer a complete catalog of dairy products).
The conglomerate merger represents the acquisition of companies specialized in other sectors. The objective is to quickly become a heavyweight in a new sector (for example, a manufacturer and distributor of dairy products buys a famous distributor of mineral water to invest in this new beverage market).
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On a daily basis, a merger-acquisition analyst carries out the following missions:
- Update data rooms during audits
- Model the financial arrangements for the growth strategy
- Establish business plans
- Monitor and conduct financial transactions
- Be constantly looking for opportunities for your clients or your company
- Find investors
- Execute purchase, sale or fundraising mandates given by clients
- Coordinate the due diligence phases
- Support leaders on a daily basis
Merger-acquisition and merger-absorption: what is the difference?
The merger represents the transmission of assets from one company to another, to form a single entity. A “simple” merger is called a “merger-absorption”.
The acquisition evokes legal control and powers at general meetings. The acquisition allows for adjustments. The acquiring company can direct the economic and commercial plan of the absorbed company. The partners of the absorbed company become partners of the acquiring company. Mergers and acquisitions leave more freedom. The acquired company may retain its name, its trademarks, etc.
-in a merger-absorption, the two companies are merged to form a single legal entity,
– the merger-acquisition leaves the legal, even commercial (at least in part) individuality of each company
The three main types of mergers and acquisitions
We can distinguish three kinds of mergers and acquisitions depending on the relationship between the companies involved.
1. Vertical merger and acquisition
When a company absorbs its supplier or customer, it expands vertically. Vertical mergers and acquisitions allow the acquiring company to extend its control over the sector.
Example of a vertical merger-acquisition: an apple distributor takes over an apple producer.
2. Horizontal mergers and acquisitions
A company can also develop horizontally by carrying out a merger-acquisition operation with a competitor or a player in the same market. It thus increases its market share by offering more services or products.
Example of a horizontal merger-acquisition: a cider manufacturer absorbs an applesauce manufacturer.
3. Conglomerate mergers and acquisitions
Finally, a company can acquire a business from another market. It forms a conglomerate which enables it to diversify its activities.
Example of a conglomerate merger and acquisition: an apple distributor takes over a dairy products distributor.
The economic and legal requirements of merger acquisition
A merger-acquisition is brewing. Many studies must be carried out prior to the merger-acquisition operation on commercial, financial, legal aspects…
It is also necessary to formalize the terms of this merger-acquisition before the operation is started (by a letter of intent or a memorandum of understanding).
These are the common phases in an M&A transaction at a glance:
1. Initial phase
2. Search phase
3. Testing phase
4. Evaluation and detailed analysis
5. Due diligence
6. Negotiation phase
7. Implementation phase
8. Handover phase
How is a M&A organised?
The merger-acquisition operation is not easy and must be studied carefully beforehand. The process is long and often requires the intervention of specialized actors. You have to know how to surround yourself to prepare a merger-acquisition operation.
1. Once the target company has been chosen, valued and the terms of the merger-acquisition negotiated, the operation begins.
2. The acquiring company must finalize the process of evaluating the acquired company and then open the Data Room to carry out Due Diligence (accounting, social, legal, tax, etc.).
3. The signing of the transfer contract marks the closing of the operation and the lifting of the last conditions. Depending on the size of the company and the field of activity concerned, the process may involve the intervention of external opinions such as the competition authorities for example.
4. Through the merger-acquisition operation, the acquired company transfers its assets to the acquiring company, in exchange for social rights.
At the end of the process, the assets belonging to the acquired company are transferred to the acquiring company in exchange for social rights. The partners of the absorbed company become partners of the new company.
In the case of companies listed on the stock exchange, the merger-acquisition rules are regulated via a public takeover bid.
A merger-acquisition operation requires a good knowledge of the target company and the risks that concern it. However, those called “compliance” are still too often misunderstood.
Finding new sources of growth is a constant objective for companies. In a constantly changing competitive environment, the strategy may sometimes consist of acquiring a company, carrying out a merger, a partnership or a joint venture. Such an operation requires a good knowledge of “the target” and the risks that concern it.
While some – financial, legal, fiscal, etc. – are subject to increased due diligence before the acquisition, so-called “compliance” risks are still too often poorly understood.
These include corruption, money laundering, terrorist financing, circumvention of sanctions… The list is long and the impacts in the event of non-compliance can be disastrous for the acquiring company.
Authorities in many countries do not hesitate to prosecute companies for failing to meet their compliance obligations. The record amounts of anti-corruption fines imposed on companies, including French ones, testify to this. In Europe, the anti-corruption law obliges managers, whose individual liability may be engaged, to deploy a program for the prevention and detection of corruption.
The agencies can carry out regular checks and have published a guide on “anti-corruption checks in the context of mergers and acquisitions”. This recalls the essentials in terms of the integrity review of the target company’s compliance system.
Operations in emerging countries
In emerging countries, the practice of mergers & acquisitions differs from developed countries, although the management of the process and the principles of valuation have many points in common. In China4, India or Brazil, for example, these differences have an impact on the formation of the transaction price and on the structure of operations.
The earnings projections (e.g. irregular free cash flow in the first years, shorter forecast horizon, and possible absence of terminal value) and the risk estimates summarized in the discount rate must be adjusted5 according to industrial knowledge of the country in which it is planned to invest. In a transaction, notable differences between emerging and developed economies include: i) a less developed system of property rights, ii) less reliable financial reporting, iii) specific cultural reference codes, and iv) stronger competition for the best operations.
1. Property rights
The sensitive points concern the ability to transfer ownership rights securely during payment, and then to ensure their protection within the framework of the laws in force (or in their absence if necessary). The transfer of ownership upon signature of the contract finalizing the transaction may be imperfect (combined for example with weak guarantees) or even reversible (in the event that administrative authorizations are required after the closing). This leads to a situation requiring time consuming and costly management. In a context where the legal framework is insufficient, it is likely that corruption problems will emerge and be a source of latent liabilities.
The information provided to a potential buyer may be insufficient with a limited level of reliability. For example, it is not uncommon for there to be double counting. Such a situation does not then make it possible to reach clear conclusions on the situation of the company concerned. The use of valuation models in this context is likely to lead to erroneous results. It is therefore necessary to begin by rebuilding a clear knowledge base, based on observable elements and the results of in-depth investigations. The objective is to have before going any further reliable intermediate balances – such as EBITDA.
A “yes” may not mean that the other party agrees, just that they understand what is being asked. Getting to the point too quickly can be frowned upon in some cultures where it is necessary to get to know each other before engaging in discussions for a transaction. Negotiations can continue until the last minute, sometimes even after the contract is signed, if the seller retains leverage in the transaction, for example in the form of a minority stake. It is therefore desirable to have a good local business network and allies before starting to make acquisitions.
The race for size in emerging markets can generate strong competition for the acquisition of the best targets, leading to price inflation and likely to be the source of insufficiently considered decisions. A period of understanding and adaptation to the market remains a prerequisite to avoid errors. If these precautions are not taken, it can lead to a low return on investment and internal tensions that weigh on the performance of the company.
It is therefore desirable that M&A tools designed for developed economies are not directly used to conduct transactions in emerging economies. A transition is necessary so that M&A teams can adapt and understand the methodological differences linked to their new environment.
Benefits of Mergers & Acquisitions
Deciding to combine companies or acquire assets can be linked to different, often multiple factors, which can range from a simple financial logic to more strategic approaches (international development, cost synergies, limitation competition, joint innovation policy, etc.):
Economy of scale.
Combining the strike force of two companies makes it possible to buy cheaper thanks to volume discounts. Similarly, the sum of the two parts makes it possible to align the pricing conditions at the lowest price. Finally, duplicates of production tools, real estate assets and human resources are often identified.
Vertical integration economy.
Having a larger part of the production chain makes it possible to better control access to raw materials upstream or to the final customer downstream and therefore in particular to control the related margins.
For example, a company may indeed be very well established in certain markets where it has a strong distribution network. The acquisition of a competitor will allow it to sell new products there where the competitor may not have had a sufficient sales force (this is typically the case when acquiring part of Seagram’s assets by Pernod-Ricard).
Eliminate a troublesome competitor (repurchase of UAP by AXA in the insurance sector).
Regenerate one’s skills by integrating new resources generally from start-ups (transfer) or by the creative combination of resources from the two merged entities (creating something new by joint innovation – cf. symbiosis acquisitions).
A company with significant tax credits is an interesting target for a highly profitable company. By adding the two parts, the purchaser will pay less tax on his profits.
Horizontal integration (with absorption of competitors) and thus reduce competition. Fewer competitors means less price competition and therefore promises better turnover, at least in the medium term.
Control additional resources.
Use of its cash. When companies are in mature and profitable markets but where there are few opportunities for development and investment, excess cash can be used to buy new businesses rather than returning that cash to shareholders through dividends or buyouts. shares.
This by bringing together the best practices of each of the parties.
Entering a new market (expansion strategy). Particularly internationally, an acquisition makes it possible to directly enter a market hitherto inaccessible to the acquirer, by circumventing certain barriers to entry.
The disadvantages of mergers and acquisitions
1. Create distress within the employee base of every organization.
The M&A process invariably consolidates positions within companies that are duplicated. This often means that there is potential for layoffs, which would put people out of work for an indefinite period. Because none of these potentials become final until the M&A process is complete, many people are forced into higher levels of uncertainty because they don’t know what will happen to them. .
2. You can increase the amount of debt owed.
If there are debts to either [or both] organizations, the M&A process may add debt to the balance sheet of the combined company. While not catastrophic in itself, this may affect the combined company’s ability to establish new lines of credit or borrow additional funds to fuel the desired expansion.
3. There may be differences in corporate culture that are not easy to consolidate.
Let’s say company A doesn’t have a formal dress code policy. They don’t even care if someone wears shorts and sandals to work every day. The atmosphere is relaxed, workers sit on sofas instead of computer chairs, and every Friday the management team steps in for their staff to enjoy a beer or two while they work. Now Company B has a formal dress code, requires compliance, and is structured with the standard office format. While drinking? Forget that. Consolidating office cultures can be more challenging than any other aspect of the M&A process.
4. It’s not a one-person decision most of the time.
Many mergers and acquisitions require many people on both sides of the aisle to be on the same page. When this does not happen, the time required to complete the merger and acquisition process may be extended. This creates additional costs to the process that can cause the risks of a merger or acquisition to outweigh the benefits the deal might generate.
5. Concealing a lack of strategy
Mergers & acquisitions can also hide the strategic insufficiency of a company’s growth project, trying to hidetes: As seen above, investors prefer clear and targeted industrial activities (“pure-play”). The underlying reason most often mentioned is that investors consider it more appropriate to diversify their investments themselves.
6. Creation of giant companies that are difficult to manage
Mergers can also lead to the creation of giant companies that are poorly integrated and therefore less agile than smaller competitors which gradually displace the market. For this reason, most groups are managed in independent divisions by product lines and market segments.
The company and its investors | What are the different types of investors?
Sources: Investopedia, Wikipedia, Corporate Finance Institute, Liberty Fund, SSRN
Photo credit: DCG_MAK via Pixabay
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