What Is The Difference Between A Merger And An Acquisition?
A merger takes place when two entities come together and leverage their strengths to form a new, unified organisation. On the other hand, an acquisition involves one entity acquiring control over another. Mergers and acquisitions (M&A) are strategic moves aimed at expanding a company’s presence, capturing a larger market share and enhancing shareholder value.
Why Do Companies Merge Or Acquire Other Companies?
Companies merge or acquire other companies to achieve strategic expansion, explore synergies, diversify and access technology. This is especially true for late stage startups and traditional giants looking to expand into new verticals. For instance, Reliance forayed into quick commerce with the acquisition of Dunzo in 2022.
Further, the rise of Thrasio-styled models in ecommerce has also led to a rise in M&A with the likes of Mensa Brands, GlobalBees and Aditya Birla Group’s TMRW acquiring a flurry of D2C brands.
The year 2022 was plagued by macroeconomic upheavals, looming fears of a recession, layoffs, shelved IPO plans, valuation cuts and waning investor interest. This led companies to consolidate in the face of adversity, and the year saw a record-high 239 M&As since 2014.
What Are The Benefits Of A Merger Or An Acquisition?
M&As offer benefits such as synergy, economies of scale, expanded market presence, diversification, increased market power, access to resources and enhanced financial performance This can lead to cost savings, improved efficiency, access to new markets and a stronger competitive edge.
However, M&A transactions entail risks and challenges, requiring careful planning and execution to maximise benefits and mitigate potential roadblocks.
What Are The Risks Associated With M&A?
M&A involves various risks that can have serious consequences:
- A party to an M&A may break the contract agreement or refuse to close a transaction, leading to disputes and potential litigation.
- Working capital adjustments and earnouts also pose challenges and can result in disagreements and legal conflicts.
- Shareholders may file lawsuits alleging a breach of fiduciary duty by the board. Other strategic disputes may also arise.
To mitigate these risks, involved parties should clear terms, conduct thorough due diligence and build trust through a well-managed process.
What Are The Stages Involved In M&A?
Once the acquirer and acquiree companies get connected and form synergies for the deal, the following takes place:
- Create A Target List: Before an M&A, both companies compile a list of potential buyers or sellers.
- Initiation Of Contact: Once companies are selected from the list, contact is established with them to gauge their level of interest.
- Sending Teaser: Companies send a teaser document to potential buyers, providing information about their products, ownership structure and potential areas of growth.
- Confidentiality Agreement: Both parties sign an essential document called the confidentiality agreement, which ensures that discussions and materials remain confidential.
- Confidential Information Memorandum (CIM): A comprehensive guide for buyers, offering detailed information about the company’s management, financial data, competition, market opportunities and more.
- Expression Of Interest (EOI): Buyers demonstrate their interest in the CIM by submitting a non-binding written offer or EOI. This offer includes details about the sale price, transaction structure and other important terms to help the seller determine the market value of their company and evaluate the buyer’s ability to complete the transaction.
- Meetings Between The Parties: Once both parties have expressed interest, they hold meetings to further explore the matter and assess compatibility.
- Letter of Intent (LOI): The buyer presents information regarding the price and deal structure in the Letter of Intent (LOI). This document includes closing dates, any break-up fees, exclusivity periods, and other transaction terms.
- Due Diligence Process: During this stage, the buyer thoroughly reviews all the documents provided by the seller to assess risks and make informed decisions. This includes examining the seller’s financials, intellectual property, customer base, ongoing litigation, technology and more.
- Purchase Agreement: It is a legally binding document that outlines the final terms of the transaction, including the purchase price, closing date, warranties, executive provisions and break-up fees.
- Pre-Closing Period: In certain transactions, a pre-closing period exists, during which the parties must fulfil conditions such as obtaining government approvals and third-party consent.
- Closing: Once all conditions are met, funds are transferred between the buyer and seller, signifying the completion of the transaction.
How Are M&As Financed?
M&As are financed through a combination of methods, including cash, stock, debt financing, equity financing, seller financing and earnouts. Cash transactions involve the acquiring company paying a predetermined amount in cash to the target company’s shareholders. Stock deals involve issuing shares in the acquiring company to the target company’s shareholders.
According to investor and financial advisor Prateek Toshniwal, cash, equity, debt or the combination of three will be popular M&A financing methods in major investment deals in 2023.
How Are The Values Of Companies Determined In M&A?
The values of companies can be ascertained using:
- Asset-Based Approach: This method determines a company’s value by subtracting its liabilities from its assets (net asset value or NAV). It involves adding all tangible and intangible assets and then deducting liabilities to calculate the company’s worth.
- Cost-Based Approach: Also known as the replacement value approach, this method considers the cost required to replicate the same business. The value of the company is directly linked to the amount needed to create an identical business.
- Market-Based Approach: This approach compares the company with similar businesses in the market. By assessing the company’s performance against its competitors, an appropriate value can be determined.
- DCF Approach: The discounted cash flow (DCF) approach, also known as the income-based approach, is a widely used valuation method. It calculates a company’s value by discounting the expected cash flows for the next five years to their present value.
How Do M&As Impact Employees?
When companies merge, acquire or get acquired, it may lead to the removal of redundant job roles within the newly formed organisation.
On the other hand, if the acquisition causes an increase in the target company’s stock price, employees who hold company stocks may experience gains.
How Do M&As Impact Institutional Investors?
M&As can impact the performance of investors’ portfolios, with successful deals contributing positively and unsuccessful ones having a negative effect. M&A activities introduce new risks and returns, prompting investors to evaluate the alignment of these deals with their investment strategies and risk tolerance.
Based on their analysis of the potential impact, institutional investors may adjust their holdings in the companies looking for a merger or an acquisition. In addition, M&A deals can alter corporate governance and voting rights, as investors with substantial stakes in the merging entities may have a say in decision-making processes.
