A successful M&A deal makes the whole greater than the sum of its parts.
Mergers and acquisitions (M&A) are common transactions in the business world, as companies of all sizes continually join forces or expand their horizons to improve their strategic position. The terms merger and acquisition are frequently used together, which can cause their business and legal definitions to be confused, although the two concepts are quite different.
In this blog post, we take a closer look at both mergers and acquisitions, the various types of each, and the differences between them. We also review some important benefits and legal considerations for M&A transactions while providing a step-by-step overview of the M&A process.
Introduction to mergers and acquisitions
Mergers and acquisitions designates a category of business transaction that includes the joining or combining of two companies in some form. This can involve one company purchasing another outright, two companies combining into one larger company, or a large company purchasing a known entity to expand their portfolio while leaving the governance structure and brand intact.
Over 50,000 M&A deals were completed in 2023 in the U.S. alone. M&A deals can be either friendly or hostile, depending on board approval and shareholder acceptance. Mergers and acquisitions are significant in the global business landscape due to:
● Competitive Advantage – M&A activity can strengthen a company’s competitive position by reducing competition or adding to their portfolio.
● Operational Synergies – Combining companies successfully can lead to improved efficiency, cost reduction, and more efficient sharing of resources.
● Enhanced Innovation – Through mergers and acquisitions, companies can gain access to new technology, intellectual property, and talent.
Mergers and acquisitions also have short and long term tax implications that can impact the corporate tax structure, deductions, capital gains, employment taxes, and other factors that should be considered before an M&A deal is completed.
Differentiating between mergers and acquisitions
The frequent use of the combined mergers and acquisitions term can lead to confusion over how they differ in meaning. To summarize, a merger is a business transaction where two independent companies voluntarily consolidate into a new entity, forming a new business structure in the process. Common types of mergers include:
● Vertical – A company merges with a supplier or customer within their existing supply chain.
● Horizontal – Two companies operating within the same or similar industries combine to form a larger entity.
● Conglomerate – Two companies in unrelated industries combine for the purpose of diversification.
Acquisitions (also known as buyouts or takeovers) do not lead to the formation of a new business, since one entity completely absorbs the other. In an acquisition deal, the buyer takes over all operational and management functions of the purchased business. Types of acquisitions include:
● Stock Acquisition – The acquiring company buys a controlling stake (more than 50%) of the target company’s shares.
● Asset Acquisition – One company acquires specific assets or business units from another without taking on the liabilities of the entire business structure.
● Management Buyout – The current managers of a company purchase all or a majority of the company assets from the existing owner.
Strategic reasons behind M&A activities
The reasons mergers and acquisitions occur, and their inherent benefits, vary significantly depending on the type of transaction and the motivations of the buyer and seller. Most companies who participate in a merger expect to reap competitive and financial advantages from the consolidation process, especially in cases where the new partner was formerly a top competitor.
A company that acquires another may seek business advantages by eliminating a key competitor from the market altogether, rather than joining forces with them. A strategic acquisition can also be motivated by market or geographic expansion. For example, a large computer maker in the U.S. might purchase a smaller computer manufacturer in Europe to broaden their footprint, rather than setting up their own international operation from scratch.
Step-by-step overview of the M&A process
A successful M&A transaction is not a one-size-fits-all proposition, but there are several key steps that must always be considered during the merger and acquisition process. Foremost among these is a planning phase where funding sources, stakeholder roles and responsibilities, and the ultimate structure of the combined business are mapped out in detail. Additional key components of the M&A process include:
● Establishing a fair market value for one or both entities involved.
● Conducting thorough due diligence to review company history, finances, operations, and critical documents.
● A legal review that allows attorneys from both parties to complete and agree to all required filings and amendments.
● A formal integration process where operational, cultural, and technical aspects of the companies are unified.
Each of these important milestones facilitates a smooth transition that is free of surprises, and a successful closure that benefits both parties.
Key legal and financial considerations
Key milestones of the M&A transaction also bring unique legal and financial considerations. Establishing a non-disclosure agreement (NDA), performing adequate due diligence, establishing the deal structure and closing conditions, and creating representations and warranties to protect legal rights are just a few of the M&A components requiring sound legal guidance.
There are also important financial elements of the M&A deal to be considered, including the finance structure and financing methods. Each financing option comes with inherent risks and benefits for both parties. While some deals are consummated through straightforward cash transactions, others involve acquisition through debt or equity raises, stock swaps, or vendor take-back loans that allow the buyer to complete the purchase in installments.
Common challenges and pitfalls in M&A deals
The array of legal and financial decisions required to complete an M&A deal highlight the risks and challenges that accompany these complex transactions. Common pitfalls to be avoided in M&A deals include:
● Underestimating the time and resources required for integration
● Overpaying for an acquisition
● Not completing thorough due diligence and identifying a liability after closing
● Neglecting cultural differences between the two companies
● Talent loss due to misconceptions or uncertainty
● Hidden or undisclosed financial liabilities
The due diligence process provides an opportunity to avoid many of these pitfalls by uncovering important financial, cultural, and legal issues early on. Companies should also focus on creating detailed post-merger integration (PMI) plans that address operational, technological, and cultural challenges upfront. Effective communication and change management strategies ensure employees and stakeholders understand the goals and benefits of the merger or acquisition.
M&A case studies
Avoiding known pitfalls increases the odds of M&A success, as we have witnessed in many previous transactions. The vertical merger of Disney and Pixar in 2006 is considered a success story for both companies. The merger combined Disney’s extensive marketing staff and distribution network with Pixar’s innovative technology and animation talent. The cultural, operational, and marketplace synergies between the two organizations has spawned many commercially successful films since the merger.
While it may be too soon to judge recent acquisition examples like Twitter (X), where over-valuation and post-deal culture clashes and layoffs may point to a lack of due diligence, other notorious M&A deals leave little doubt in their lack of success. When wireless carrier Sprint acquired Nextel for $35 billion in 2005, they did not account for important differences in culture, technology, and operations that eventually led to high employee turnover and (eventually) the sale of Sprint to T-Mobile for $26 billion.
Future trends in M&A
High interest rates and geopolitical uncertainty are among the driving factors behind a recent slowdown in M&A activity, but this trend is expected to be reversed in the years ahead. Additional M&A trends of interest include:
● Large technology companies pursuing acquisitions that increase their artificial intelligence (AI) capabilities.
● An increased number of acquisitions and vertical mergers in the healthcare space.
● Preferential M&A activity for companies with strong sustainability commitments.
● More small and midsize M&A deals.
Companies can prepare for a successful integration by ensuring they are able to withstand the scrutiny of the due diligence process, while taking the time to understand and communicate their own goals and vision both inside and outside of the organization. Companies considering M&A deals should also understand that it is never too early to develop their ideal post-merger governance structure.
Mergers and acquisitions: Final thoughts
Mergers and acquisitions play a vital role in shaping the business landscape, offering companies pathways for growth, diversification, and competitive advantages. The success of an M&A deal depends on thorough strategic planning, meticulous due diligence, and a robust integration process. It’s essential for companies to maintain a flexible approach throughout the M&A process, allowing for adaptability in response to changing market conditions and unforeseen challenges. Companies that carefully assess financial and legal risks, foster cultural alignment, and implement clear communication and change management strategies are likely to achieve a successful transition and lasting organizational value that benefits all stakeholders.