Martin Barraud/Getty Images
How Acquisitions Work
Acquisitions can be the amicable result of friendly discussions between two firms in which the target company welcomes the acquisition. In this situation, the two companies negotiate the terms of the acquisition and ultimately reach an agreement. However, acquisitions can also occur against the will of the acquired firm’s management in what is called a “hostile takeover.” In a hostile takeover, an outside firm acquires a controlling interest in the target firm by purchasing more than 50% of the target company’s shares. This is done by offering the existing shareholders a higher price for their shares than what they could currently get on the open market, thereby enticing them to sell.
Types of Acquisitions
An acquisition can be paid for in cash, through a security payment such as a stock-for-stock exchange, a leveraged buyout, or a combination of several of these methods. A company can acquire another by giving cash to the existing shareholders of the target company for their shares. This is the simplest form of payment. In a security payment, the acquiring company will offer new securities in exchange for the securities and assets of the target company.
Acquisitions vs. Mergers
The words “acquisition” and “merger” are often used interchangeably in practice, but the two are technically distinct. In an acquisition, the target company is folded into the acquiring company and ceases to exist. In a merger, two firms combine to form a new company.
Pros Explained
Economies of scale: Larger companies can buy material in bulk to streamline expenses as well as increase efficiency through specialization.Increased market share: If an acquisition combines two companies in the same industry, then the new company gains the combination of each firm’s market share.Vertical integration: Vertical integration occurs when a business buys another in its own supply chain.Synergy: When two firms merge, they can often reduce overhead by eliminating redundant functions. This expense reduction directly improves profitability.
Cons Explained
Integration issues: If the cultural or operational climate isn’t compatible between the two firms, there may be problems integrating the two.Overestimating synergies: It takes time to combine two companies and integrate them into one cohesive firm. A transition time must occur before synergies are fully realized.Paying too much: The selling firm and its shareholders will naturally want the highest price they can get, and other parties involved in the transaction may be willing to pay more just to get the deal completed.
