What Are Mergers and Acquisitions? (Plus Pros and Cons)

By Indeed Editorial Team

Published 27 April 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Mergers and acquisitions (M&A) are transactions companies use to change ownership and consolidate their position in a market. Although both transactions have similarities, a merger differs from an acquisition. Understanding how a merger and acquisition works can help you increase the market access of a company and boost its profits. In this article, we explain what a merger and acquisition is, discuss the difference between the two, outline their types, share the steps involved in the M&A process and list the pros and cons of M&A.

What are mergers and acquisitions?

Mergers and acquisitions involve a series of processes and can take several months or years before the parties agree. Companies or organisations merge or acquire others to consolidate their assets and improve their market share. People often use the terms mergers and acquisitions interchangeably, but they differ in meaning.

A merger occurs when two companies come together to form a single company. The stocks of the merging companies cease to trade and are issued in the name of the new company. An acquisition involves one organisation buying the assets of another organisation. The assets of the target organisation become that of the buyer, but the acquired organisation doesn't change its structure or name. The stocks of the acquired entity become that of the buyer and cease to trade under its former name.

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Types of mergers

Here are the common types of mergers:

Vertical merger

This is a merger between two companies that sell different products or services but share common supply chains. The merger allows the new company to gain more control of the supply chain process, increase synergies and ramp up business. A vertical merger often results in increased productivity and efficiency and reduced costs.

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Horizontal merger

This involves the merging of two companies in the same industry. Horizontal mergers often result in a way to eliminate competition by forming one powerful company instead of two competitors. They can help the merging companies capture a larger market share, achieve economies of scale and enjoy merger synergies.

Conglomerate merger

This refers to the process where two organisations that share no similarities become one to benefit from scale, share assets and reduce risks. A conglomerate merger has two types: puree and mixed conglomerate mergers. In a pure conglomerate merger, the merging companies are unrelated and serve different markets. A mixed conglomerate merger helps companies expand product lines or access new markets.

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Product extension merger

This merger involves two companies selling related products or services in the same industry. Both companies often share similar supply chains, production processes and distribution channels. The goal of the merger is to allow the two organisations to group their services or products together to increase market access and boost profits.

Market extension merger

This refers to the merging of two organisations in the same industry, but different markets to access a larger number of customers. The organisations involved often sell the same services or products. The merger aims to gain a larger client base.

Types of acquisitions

Here are examples of acquisitions:

  • Value creating acquisition: This acquisition is where a company buys a business to make a profit. Rather than absorbing the target company, the acquiring company enhances the firm's performance and sells it to the highest bidder.

  • Consolidating acquisition: Consolidating acquisition is the process where an acquiring company buys another company to decrease competition.

  • Accelerating acquisition: This involves a bigger company buying a smaller company to increase the market access of the target company's services or products.

  • Resource acquiring acquisitions: This involves an acquisition in which a company buys another business to have access to the acquired firm's resources, such as market access, personnel, skills or intellectual property. The rationale behind this transaction is that the acquiring company can save cost and time if it buys an existing company with the structure it needs, rather than create a new one.

  • Speculating acquisition: This is when a larger company buys a smaller business to gain from the potential growth of the acquired company's new products or services.

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Steps involved in merging or acquiring companies

Mergers and acquisitions involve lengthy and usually secret negotiations between two organisations. The larger of the two companies often take the first step, followed by deliberations between their boards. Here are steps involved in merging or acquiring companies:

  1. Create acquisition or merger strategy: The first step is to develop a robust strategy to guide the process of M&A. This document outlines the purpose of the transaction, the potential gains for the two companies, how to raise funding and how to convince stakeholders.

  2. Develop search requirements: The next step is to determine the criteria for identifying target companies. These requirements can depend on the smaller company's customer base, market share, supply chain, product lines or geographic spread.

  3. Identify targets: Next, the acquiring organisation identifies companies that meet their search criteria. These may depend on the financial status, market share, prospects and other factors that can help the acquirer achieve its objectives.

  4. Create an acquisition plan: Once the acquiring company identifies potential targets, it contacts them with an initial offer. If the target company's reply is friendly, the relationship can take on a mutual tone from the start.

  5. Conduct a valuation: If the target company is amenable to an acquisition or merger, the acquiring company may request information about its financial health. This can provide deep insights into the company's product performance, finances and other important metrics that can help the larger company make an informed decision going forward.

  6. Conduct negotiations: If the acquiring company is satisfied with the target company's valuation, the two sides can start negotiations.

  7. Perform analysis: This step involves a comprehensive analysis of the acquiring company's valuation of the target company. Auditors may check the smaller company's client base, finances, personnel, market share, production capacity and other variables.

  8. Prepare the purchase and sales agreement: If the analysis finds no serious errors in the valuation, the companies involved prepare to sign a sales and purchase agreement. The contract transfers the assets or shares of the target company to the acquirer.

  9. Discuss financing options: Once the companies sign the sales and purchase agreement, the acquiring company reveals the financing options it may use to execute the transaction.

  10. Close the deal: The last step of the M&A process is to close the deal and merge the companies according to the guidelines of their agreement.

Benefits of M&A

Acquiring companies or merging companies can bring several benefits to those involved with the business. These benefits may include:

  • Lower labour costs: When companies come together to form a single company, they may eliminate redundant positions or extraneous staff. This can reduce the company's overall labour costs while maintaining a stronger, more effective labour force.

  • Improved economic scale: A larger company, or one that has joined forces with another company, typically has higher needs in terms of supplies and materials. By acquiring the smaller company's supplies and raw materials, the larger company can improve its scale through lower costs and pass those lower costs onto its customers.

  • Increased market share: When two organisations come together that provide similar goods or services or operate in the same industry, the newly formed organisation can enjoy a greater market share. They can tap into the resources that both bring to the business deal.

  • Enhanced distribution capacities: An M&A may expand a company geographically, increasing its ability to distribute services or goods on a wider scale.

  • More financial resources: All companies involved in an M&A pool their financial resources, which may increase the new company's overall financial capacity. Also, new investment opportunities may present and the new company may reach a wider audience with more significant inventory capabilities or a larger marketing budget.

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Downsides of M&A

Although M&A can be beneficial for the companies involved, certain downsides may present. Some examples of potential drawbacks associated with M&A include:

  • Potentially lost opportunities: The money, energy and time that goes into an M&A may require the companies involved to forego other potential opportunities.

  • Increased legal costs: Merging two organisations is a legal business transaction that usually requires the involvement of a number of key professionals, which can increase legal costs. Those involved may need lawyers who specialise in M&A and financial professionals who can assist with the assets and other financial details.

  • High expenses associated with the deal: Aside from paying professionals who can assist with the logistics of the M&A, the company that's acquiring the other is responsible for paying a sum of money for that business and its assets.

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