Mergers and acquisitions are common growth strategies business. Most of us are familiar with the way we see it play out within the world’s largest companies. For example, Facebook acquired Instagram for a purchase price of $1 billion in 2012. That same year, much to the dismay of "Star Wars" fans everywhere, Disney acquired Lucasfilm in a $4.05 billion deal.
Though mergers and acquisitions usually only enter the public lexicon when it’s happening with a large public company, M&A deals do happen in the world of small business. In some respects, it’s a major goal for startup founders when they’re still running a private company: Either they get acquired or they become big enough to acquire. The majority of startups that become an acquired company are typically bought out after raising Series C funding.
So, what’s the real deal with acquisitions and mergers? How can your company pave the way for the best chance of success, and what can you expect?
What Are Mergers and Acquisitions?
"Mergers and acquisitions" is a catch-all term to describe when companies consolidate assets. This happens in a number of ways, from financial transactions like tender offers and the purchase of assets or management acquisitions to new joint ventures. M&A can also be used to describe the corporate finance department that handles M&A transactions.
Mergers vs. Acquisitions
Mergers and acquisitions are slightly different. A merger is when two firms of the same size band together and create a single entity — like when Disney and Pixar, which had one of the most successful mergers of all time, became Disney-Pixar. This is known as a “merger of equals,” and both companies surrender their individual stock and start issuing shares under their new company’s name. Purchase deals are also called mergers when two chief executives agree to embark on a joint venture.
An acquisition, on the other hand, is when the acquirer takes over a target company and becomes the new owner. The acquired company is absorbed into the company that purchases it, and it no longer exists as a single entity. For example, when Facebook acquired Instagram, Instagram was absorbed and lumped into Facebook’s IPO. Instagram may still be a stand-alone app with its old branding, but it does not trade its own shares on the stock market.
One of the other main differences between a merger and acquisition is the vibe of the purchase deal and how it’s described to the company’s board of directors, shareholders and employees. If it’s hostile and a company does not want to be purchased but it happens anyway, it’s often considered an acquisition. If it’s a welcome deal and a willing partnership, then it’s usually considered a merger.
Types of Mergers and Acquisitions
There’s not just a single type of M&A process. There are actually a few different types of transactions that are considered M&As. These include:
- Mergers: This is when two companies become a new company with the approval of the board of directors (and hopefully shareholders too). For example, in 1998, Exxon Corp. and Mobil Corp., the two largest oil producers in the United States at the time, became Exxon-Mobil in an $80 million deal that ultimately quadrupled investor money.
- Acquisitions: This is when a company obtains a majority stake in another company. That company doesn’t end up changing its name or legal structure, but it does cease trading on the stock market. For example, in 2014, Comcast acquired Time Warner in a $45.2 billion deal. It was the 16th largest acquisition in history; however, Comcast also acquired Time Warner’s debt of $67 billion.
- Consolidation: After this type of merger is approved by two separate companies, they’re both given equity shares in a brand-new company. For example, this happened in 1998 when the bank Citicorp and the financial services company Traveler’s Group became Citigroup Inc. This transformed Citi into the largest bank in the world, but it didn’t necessarily perform better on Wall Street. Two decades post-merger, Citigroup’s stock was down 80%, though the stock market as a whole had doubled.
- Tender offer: This is when the acquiring company purchases outstanding stock of a target company. This deal is done directly with shareholders, bypasses board approval and is often hostile. For example, in 2008, Euro-Brazilian beverage company InBev made an unsolicited offer for Anheuser-Busch for $65 per share. During this deal, InBev tried to have Anheuser-Busch’s entire board of directors fired and eventually convinced shareholders to accept by upping the offer to $70 per share ($52 billion).
- Acquisition of assets: In this type of deal, a company acquires the assets of another company through the approval of shareholders. This can be physical assets happening during a bankruptcy proceeding, intellectual property or a management team. The acquired company is liquidated once the assets are transferred.
- Management buyout: This is when the company’s own management team buys the business they manage, like when chief executive manager Michael Dell purchased Dell Corporation in 2013. These are popular investments for hedge funds and private equity firms because a business will usually remove itself from the stock market and go private, giving a massive opportunity to improve profitability, streamline processes and grow its market share without public scrutiny.
- Management buy in: This is the same as a management buyout except the majority stake is purchased by an outside management company.
How Do Mergers Work?
Mergers and acquisitions can be categorized a number of ways, but typically, the currency involved is cash, stock or a combination of both, and a company buys all or a majority share of assets.
M&As are categorized by the type of companies involved. For example, the most popular types are horizontal mergers, where two companies with similar product lines and target markets combine, and vertical mergers, where a customer and supplier will combine, but there are also:
- Congeneric mergers: When two different types of businesses with the same consumers merge — for example, a broadband provider and a laptop manufacturer
- Market-extension mergers: When two companies that sell the same product to different markets merge
- Product-extension mergers: When two companies merge that sell different but related products in the same market — for example, a company that manufactures espresso makers teams up with a company that manufactures K-cup machines
- Conglomeration: Two companies merge when they have nothing to do with each other
Beyond this, M&As are also categorized by the type of financing in either purchase mergers or consolidation mergers. Purchase mergers happen when a company purchases another company, usually with cash or some sort of debt financing. For example, with a leveraged buyout, a company uses borrowed loans to make an acquisition it wouldn’t otherwise be able to afford. Consolidation mergers are similar, but in this method, two companies are purchased and transformed into a new company.
Pros of Mergers and Acquisitions
There’s a reason so many companies fall the way of M&As — they’re helpful and have historically proven to reduce costs. A merger between companies with similar products can immediately improve economies of scale. For example, you can reduce costs if you can buy raw materials in greater bulk. It may also help get rid of staffing redundancies, which will reduce labor costs.
Beyond saving cash, M&As can increase the market share of a company (if the companies happen to be in the same market) and increase the distribution capabilities. For example, U.K. telecom company Vodafone expanded into the U.S. through a 1999 cross-border merger with Bell Atlantic’s mobile division, which gave us Verizon Wireless.
M&As also give companies access to an improved pool of talent (two teams of highly skilled workers are better than one) and more financial resources. The latter follows the premise that you have more money if you pool your bank accounts unless you happen to be the company that purchased another’s debt. This occurs when a company uses discounted cash flow to weigh a company on its potential future cash flow instead of its current finances.
Cons of Mergers and Acquisitions
An M&A can really help propel a company forward, especially when it is struggling, but it’s not always the right move for every situation. M&As are notoriously expensive, and the acquiring company has to know that it is worth it. For example, Yahoo made the huge mistake of purchasing the social network Tumblr for $1 billion in 2013. The investment proved to be so poor that it sold it off to Verizon six years later for less than $3 million, which is cheaper than some New York apartments.
In addition to the exorbitant costs (corporate law firms aren't cheap if you're planning a hostile takeover), there’s a chance the public won’t like a merger, and a stock will plummet. Losing customer trust can be a killer. For example, customers were organizing a boycott of Blue Bottle Coffee when it was purchased by Nestle for up to $500 million in 2017. This was largely because of Nestle’s controversial bottling practices that allegedly harmed communities where water was scarce.
How to Have a Successful M&A
It’s not a safe bet that an M&A will be successful, but there are things companies can do to position themselves toward success, whether they’re the acquiring company or the one for sale. It’s important to do your due diligence. This includes:
- Knowing the company's value: There are a lot of different ways that companies are valuated in M&As, but the most important thing is that you know the costs. Companies can lose millions purchasing a company at an inflated price — just look at Yahoo and Tumblr.
- Knowing your partners: In order to understand if you have a valuable opportunity, you should know everything you can about your potential partners. How do they operate? Do they have any shady practices? How do employees feel?
- Talking to customers: Talk to both your customers and the prospective company’s customers. A merger will not be successful if your business is not embraced by the other company’s consumers, so figure out what they like and how they think the other company can improve.
- Having a financial expert dive deep into the books: If you’re merging with or acquiring another company, you’re also acquiring its debt and legal issues. Learn its finances inside and out and make sure its books don’t have any concerning inconsistencies or that it hasn't been in trouble with the IRS.
- Diving into operations: Like with finances, you need to know exactly how the company with which you’re partnering works. Learn all you can about its daily procedures, its team and where it succeeds or falls short.
One of the most important things beyond valuation is to make sure the team fits. A company will not be successful if its employees are not successfully merged or resent the acquisition. You may need to get rid of an entire team, hire a new CFO, etc. This is something that should be figured out before the merger so you don’t end up with a staff full of people who can’t do or won’t do their jobs to the best of their ability.
- CNBC: Disney Bought Lucasfilm Six Years Ago Today and Has Already Recouped its $4 Billion Investment
- Techcrunch: Here's How Likely Your Startup is to Get Acquired at any Stage
- Combin: Instagram Stock: Everything You Want to Know
- Business Insider: The 16 Biggest Corporate Mega-Deals of All Time
- Marketplace.org: The "Titanic" of Wall Street: The Citigroup Merger 20 Years Later
- Investopedia: What Are Some Top Examples of Hostile Takeovers?
- Investopedia: Management Buyout (MBO)
- The Telegraph: Blogging Site Tumblr Sold for 'Less Than $3m' – Six Years After Yahoo paid $1bn For It
- Business Insider: Blue Bottle Coffee Now Has Some of the Same Problems as the Craft Beer Industry — and Customers Are Ready to Boycott
- Shopify: Mergers and Acquisitions (M&A)
- Investopedia: Mergers and Acquisitions - M&A