Why Might a Company Invest in Another Company's Stock?

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Outside of stock brokerages and hedge funds, investment is not the core activity for most businesses. Nevertheless, every day you can read business news about one company buying shares in another company. The reasons range from breaking into new markets to acquiring cutting-edge tech.

TL;DR (Too Long; Didn't Read)

Companies often buy stock in other businesses to gain control of them. This may give them access to new markets and customers or control of the acquisition's valuable assets. Buying a competitor is another reason for investing in other firms.

Who Can Do It?

Investing in stock isn't an option for every business. A corporation can do it because corporations are legal individuals with the same right to buy stock as any legal person. On the other hand, a sole proprietorship or partnership isn't separate from its owners, so it cannot invest in stock. The owners can, however, buy as individuals.

One company buying shares in another company is only possible if the second business is incorporated and has shares to sell. A partnership, for example, has no shares. It's possible for a corporation to invest in a partnership but not by way of buying stock.

Why Buy Another Company?

You'll find one company buying shares in another company for a variety of reasons:

  • Size. Some executives and business owners want to buy more companies just so their business can be bigger and with more assets. Marvel Comics, for example, bought a rival comics company in the 1990s to keep themselves the largest publisher in the industry.

  • Age. As a company's business matures, it no longer has room to expand by selling more products. Buying a competitor and hopefully bringing their customers into the fold is a way for mature companies to keep growing

  • Some successful companies have a high cash flow and nothing on which to spend it. Investing in other companies may bring a better return than putting the money in a bank.

  • To eliminate competition.

  • A bigger company has more clout negotiating with its suppliers.

  • Diversification. If, say, a computer company wants to enter the video game market, buying an established company might be easier than trying to enter under its own power.

  • Broadening the market. IBM, for example, has bought several small tech companies and used IBM's sales force to promote their products better than the smaller companies ever could.

  • It's often cheaper and faster to buy tech than to invent it. Apple didn't invent Siri, for example. It bought the personal assistant software along with the company that invented it.

Holding Company vs. Parent Company

The acquiring company can simply choose to become a minority stockholder and treat stock dividends as another income stream. However, a minority position leaves stockholders vulnerable to the will of the majority. Many companies would prefer the power that comes with majority or even 100% ownership.

When a company buying shares in another company becomes the majority stockholder, it has to choose between doing it as a holding company vs. a parent company.

  • A parent company is the majority stockholder in a subsidiary company. Unlike a merger, the two companies are legally separate. However, the parent company exercises considerable control over the subsidiary's operations due to the parent's status as majority stockholder.

  • A holding company is a special case_._ A holding company and a subsidiary company have the same power dynamic as a parent/subsidiary, but a pure holding company exists solely to own the stock in other firms. It doesn't engage in its own operations. Other holding companies conduct their own operations as well as holding stock in other firms.

Questions to Ask

Before investing in another company, it's wise to think it through and confirm that it's a winning strategic move for you.

  • Does the acquisition fit in with your strategic growth plans for your company?

  • Understand what you want to gain. Access to new markets? Ownership of new technology?

  • Is someone on your management team ready to "own" the acquisition and commit to its success?

  • Will this hurt by drawing focus away from your customers or the subsidiary's customers?

  • Is your culture compatible with your potential acquisition's culture?

  • What benchmarks do you have to determine if the acquisition is working out?

References

About the Author

Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com

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