When one company invests in another, you may hear it described as an amalgamation, merger, acquisition or consolidation. In casual conversation, the terms may be used interchangeably, but they have separate definitions. The outcomes range from combining two companies into a third, totally new business to company A becoming the majority stockholder of company B.
TL;DR (Too Long; Didn't Read)
In a merger, Company A and Company B become one corporation, calling itself by Company A's name. Consolidation's business meaning is that Company A and Company B become a new corporation, named Company C.
Amalgamation, Merger, Acquisition or Consolidation
Amalgamation, merger, acquisition and consolidation all involve corporations combining their assets, but each means something different.
- Merger. Two corporations become one. For example, suppose Company A and Company B merge into a single organization. To do this, Company A, called the survivor company, assumes all the assets and liabilities of Company B, which ceases to exist. The survivor company keeps the Company A name.
- Consolidation. Companies A and B join together to become a new business, Company C. The new business is known as the successor company. Some state laws use the term "merger" for consolidations too.
- Acquisition. Company A takes over Company B without merging or consolidating. This can be done by buying 51% of the stock or more. In an asset acquisition, Company A buys up most or all of Company B's assets. Unlike a merger or consolidation, acquisition doesn't require A to assume B's liabilities.
- Amalgamation. Company A takes over B and possibly C and D as well. This can be done by merger, consolidation or acquisition.
There are multiple types of mergers, acquisitions, consolidations and amalgamations. The effect on stockholders and the legal issues vary with the category and type of combination.
Why Combine Companies?
Corporate leaders and investors may prefer the status quo rather than putting themselves under the control of some new business entity. However, there are often advantages to turning Company A and B into a single organization.
- Creating a stronger company. A and B may be no match for C, which dominates the industry. Combine A and B together and they become the big dog in the field. They'll also have more resources and the best employees of both corporations to draw on.
- Eliminating competition. If A buys up B, it no longer has to worry about B as a rival.
- A larger company has the clout to arrange cheaper terms for its financing.
- Bigger companies have more bargaining power with suppliers and clients.
- Amalgamating with B may give A access to new markets, new technologies or new clients.
What Happens to Stockholders?
Stockholders have a vested interest in what happens to the company they own shares in. The effect on them depends on how the combination takes place.
In a merger or a consolidation, for instance, Company A may offer to buy up shares from Company B's stockholders or to swap them for shares in the combined company. A majority of shareholders have to vote in favor of combining; naysayers can refuse to swap shares and ask for cash based on the appraised value of their stock.
A stock acquisition doesn't require a shareholder vote, but A will have to offer enough to B's stockholders to collect the number of shares it wants. An asset acquisition doesn't usually require a shareholder vote. Neither does a "short-form" merger in which Company A owns at least 90% of B's stock.
Types of Mergers
There are multiple types of mergers and acquisitions, depending on whether the companies compete, do business or exist in unrelated worlds.
- In a conglomerate merger, A and B are in separate industries. Amazon, for example, merged with the Whole Foods grocery chain in 2017, giving the chain badly needed financial support. In return, Amazon established a niche in the grocery business and acquired valuable real estate in hundreds of upscale neighborhoods.
- Horizontal mergers take place between competing companies. If Whole Foods had merged with the Kroger chain, that would have been horizontal. This strategy reduces competition and increases the combined company's market share.
- A market extension merger combines companies separated by geography. A New England business that merges with a company in the South expands its range of operations and potential customer base.
- A vertical merger takes place between two companies in the same supply pipeline. If a steel manufacturer merges with its iron ore supplier, that would be vertical.
- Product extension mergers take place between companies that operate in the same market and have related products.
Consolidate To Transform
In some mergers or consolidations, the strategy is a big-picture one. Company A doesn't want to become more powerful in the industry, it wants to transform the industry or itself.
Self-transformation is possible because consolidating into a new company often leads to massive shakeups. Rather than simply have Company A impose its corporate culture on B, the leaders put their heads together and come up with a new, superior culture and methods of operation. As everyone on both teams is expecting things to change, they're more open than usual to new ways of doing things.
Executives in highly competitive cut-throat industries sometimes hope that consolidating will reduce price competition. That makes it easier for everyone in the industry to earn a higher return on investment. Unfortunately, unless consolidation reduces the players to three or four companies, it's unlikely to transform pricing strategies much.
Special Merger Cases
The reverse merger is a special case, involving a private company that has mixed thoughts about going public. Selling stock in an initial public offering (IPO) is a good way to raise capital, but it can also dilute the owners' control of the business.
One solution is to use stock acquisition to buy up a controlling interest in a company that's already trading publicly. The two companies merge, with the private company's shareholders becoming majority shareholders in the public company. The private company eventually becomes a wholly-owned subsidiary of the publicly traded corporation, but with no risk to the owners' control.
The short-form merger is another useful option because it dispenses with much of the ordinary merger paperwork. It requires Company A to already own around 90 percent of B's stock, though some states set a slightly different percentage. The minority stockholders in B have no power to block the sale, so state laws allow Company A to waive many of the meetings normally required.
The Price of Acquisition
Making an acquisition of Company B without merging or consolidating has advantages, as it's a much simpler legal process. Either Company A makes the current stockholders an offer for their shares or it offers the corporation money for its most valuable assets.
An asset acquisition allows Company A to pick and choose the assets it wants, which could be land, equipment or intellectual property. However, B's management doesn't have to say yes if the price isn't fair. It may take a flock of accountants, analysts and appraisers to determine if A's offer for the assets is a good one.
Acquisition can boost company A's profits in multiple ways:
- By slashing Company B's costs or boosting revenues, A turns B into a dependable source of cash.
- The industry's putting so much product on the market that everyone suffers. Buying Company B and reducing production may increase prices for A's products.
- If B suffers from limited marketing or sales and A has a first-rate sales department, A can channel B's products through A's larger sales force.
- If Company A is, say, a tech firm, it may want to buy up smaller firms with products that match up with its own. This is often quicker and cheaper than investing in its own R&D.
- Company A sees Company B is in on the ground floor in a new industry. Acquiring B gives A access to the new field.
If the acquisition price is too high, the purchase isn't such a good deal. However, if Company B's value or stock price drops temporarily, A may be able to snatch it up at a bargain price.
Acquiring Corporate Liabilities
When deciding between a merger, acquisition or consolidation, Company A needs to think about not only Company B's assets but B's liabilities. Say B is an IT company with some amazing patents Company A would love to possess. If B is also heavily in debt or facing patent lawsuits, the gains from B's assets may be outweighed by the liabilities.
In a consolidation or merger, for example, the successor or survivor company inherits the whole package: all of the original company's assets but all their liabilities too. Company A may be in a position to shrug that off, as when Amazon purchased Whole Foods, but not everyone's that well-placed.
If Company A buys a majority stake in B, the liabilities remain B's legal responsibility, but as A now owns B, they still have to be dealt with. Acquiring B's assets, on the other hand, enables A to avoid any liability issues, with a few exceptions:
- Company A expressly guarantees it will assume B's liabilities, or makes an implied guarantee.
- Company A continues the seller's business and retains the same staff B's always had.
- The sale is a fraudulent maneuver designed to avoid liability.
The Hostile Takeover
Another way to think about combining companies is that there are two types of mergers and acquisitions: hostile and friendly. In a friendly takeover, Company B's management and board are willing to go along. In a hostile takeover, they reject Company A's offer and oppose the merger, acquisition or consolidation.
In a friendly takeover, Company B agrees to the proposed terms Company A offers. If shareholder approval is necessary, the board recommends the shareholders vote yes. If instead, Company B rejects the offer, it may be for a variety of reasons:
- Company A is in a different industry and B's board don't think it'll operate well in B's world.
- B's board is concerned A just wants to strip mine B's assets and then leave B on life support.
- B's board or management believe they'll lose out in a consolidation, even if the shareholders do well.
Company A can still take its case directly to the shareholders. It can make them an offer for their shares or it can try to persuade them to vote out the board and install members who will be more supportive of consolidation.
Success or Failure?
Whether the combination of Companies A and B is by merger, acquisition or consolidation, it's usually a gamble. Instead of creating value, combining companies can destroy value. For instance, AOL and Time Warner made the biggest merger in history back in 2000, but the hybrid company broke apart within the decade.
There are many reasons why acquisitions and mergers often fail:
- The purchase price is too steep. Getting control of Company B or its assets often requires paying more than B is worth.
- Managers often overestimate their ability to judge the value of the target company or to manage it well once they control it.
- Company A's management team may not be acting in the company's interest. The A team may hope they'll be rewarded with bigger salaries and bonuses once they're in charge of a bigger corporation.
- Blending the companies proves tougher than expected. Deciding which plants to close, which employees to lay off and which brands to discontinue won't be easy.
- Sam Houston State University: Merger & Conslidation
- Upcounsel: Difference Between Merger and Amalgamation
- Wolters Kluwer: What Is the Difference Between Mergers, Acquisitions and Conversions?
- Corporate Finance Institute: What Is Amalgamation?
- Atlantic: Why Amazon Bought Whole Foods
- Minority Business Development Agency: 5 Types of Company Mergers
- Upcounsel: Reverse Merger Transaction: Everything You Need to Know
- McKinsey: The Six Types of Successful Acquisitions
- Wolters Kluwer: Mergers, Consolidations, Share Exchanges
- CFI: Friendly Takeovers vs Hostile Takeovers
- New York Times: What Happened to AOL Time Warner?
- Inc.: The Top Four Reasons Most Acquisitions Fail