This article has been written by Nishtha Jain, a fourth year student from Symbiosis Law School, Noida. She has briefly discussed the meaning of mergers and acquisitions along with different types of mergers. Further, she has elaborated on the motives behind the companies opting for mergers and acquisitions.
Rationale behind mergers and acquisitions
Breaking all records, India has entered the $100 billion club in the mergers and acquisitions (M&A) space in 2018. In the corporate world, there are frequent bouts of ‘merger mania’ where the level of M&A activity is very high. This trend has now again resurfaced; for instance Facebook took over WhatsApp and Instagram, Walmart-Flipkart deal, etc. For good or bad, we are yet to figure that out but what is assured is that M&A is considered as one of the basic subjects which every law aspirant should be fully aware of, especially those who are dreaming of making it big in the corporate world.
Due to increasing interest amongst the global business community to get a share of huge consumer base in India, India’s M&A outlook looks promising – Pankaj Chopda, Director at Grant Thornton India LLP. Getting access to a larger consumer base could be one of the reasons why a firm would opt for an M&A deal. Let’s identify what could be the other reasons.
M&A are usually used interchangeably, however there is a slight difference between them which makes them distinct from each other. They are based on the company’s vision and mission statements. A proper course of action and procedure is followed to undertake M&A governed by various legislations such as Companies Act, 2013, Income Tax Act, 1961, etc.
What are Mergers and Amalgamations?
In simple terms, merger is defined as a combination of two or more companies into one. They are usually considered as a means to a long-term business strategy. ‘Merger’ as a term is not explicitly defined in neither Companies Act, 2013 nor Income Tax Act, 1961. However, the Income Tax Act defines an analogous term – ‘amalgamation‘. Amalgamation refers to the merger of one or more entity with another entity, or merger of two or more entities to form one entity.
Mergers and amalgamations are of various types depending upon the needs of the merging entities. One of the ways in which a merger can take place is in a situation wherein the assets and liabilities of a company gets merged or transferred or vested in another company. The shareholders of the merging company become shareholders of the merged company and the merging company loses its identity. Another way is when the assets and liabilities of two or more companies become vested in another new company. The merging companies lose their identities and the shareholders of the merging companies become shareholders of the new company.
Situation 1: A (merging company) + B = B (merged company)
Situation 2: A (merging company) + B (merging company) + C (merging company) = D (merged new company)
What are Acquisitions?
In simple terms, acquisition refers to purchase of the shares or assets and/or liabilities of a company (target) using the stock, cash or other securities of purchaser’s company (acquirer). Acquisition is also known as takeover. It may be hostile or friendly.
Illustration – Company A (acquirer) takes over the majority shares of Company B (target). Both the companies continue to be in existence.
What is the difference between Mergers and Acquisitions?
When two companies combine together to form one company.
When one company is taken over by another company.
Acquired company ceases to exist and becomes a part of the acquiring company or forms a new company.
Acquiring company takes over the majority stake (shares or undertakings) in the acquired company. Both the companies continue to be in existence.
When the companies mutually decide to merge their companies in the best interest of their firms.
Acquisition maybe hostile or friendly.
Usually between companies of relatively equal size.
Usually a larger company purchases a smaller company.
Example – Disney and Pixar
Example – Google acquired Android
What are the types of mergers?
- Horizontal Mergers
This kind of merger takes place between companies engaged in competing businesses which are at the same stage of industrial process. Illustration – Two companies involved in the manufacture of two similar kinds of cars, one company may decide to merge with the other company so that both types of cars can be sold in the market without any competition. Examples – Myntra and Jabong merger, Flipkart and Myntra merger, etc.
- Vertical Mergers
This kind of merger takes place between companies engaged at different stages of the industrial process or production process. Illustration – To manufacture a car, tires are required. A big automobile company may merge with a company involved in manufacturing of tyres. One of the examples is the merger between eBay and PayPal.
- Congeneric Mergers
Merger between companies engaged in the same general industry without any common customer – supplier relationship. A company uses this type of merger in order to use the resulting ability to use the same sales and distribution channels to reach the customers of both businesses. Example – Citigroup’s acquisition of Travelers Insurance.
- Conglomerate Mergers
A merger between companies that are engaged in totally unrelated business activities. The principal reason for a conglomerate merger is utilization of financial resources, enlargement of debt capacity, and increase in the value of outstanding shares by increased leverage and earnings per share, and by lowering the average cost of capital. Example – Walt Disney Company and the American Broadcasting Company merger.
- Cash Mergers (also known as Cash-out Merger or Freeze-out Merger)
The shareholders of one company receives cash instead of shares in the merged company. This is essentially an exit for the cashed out shareholders.
- Triangular Mergers
It is a tripartite arrangement in which the target merges with a subsidiary of the acquirer company. It is often resorted to, for regulatory and tax reasons. There are two types of triangular mergers –
- Forward triangular merger – when the subsidiary survives, even after the merging of the target into the subsidiary.
- Reverse triangular merger – when the target survives after the merging of subsidiary into the target.
Why do companies engage in M&A?
- Gain scale and/or scope
A good M&A strategy focused on gaining economies of scale or economies of scope in turn helps in the growth of the company by leaps and bounds. Various benefits are –
- Helps companies eliminate certain execution risks if they are looking forward to a mass scale. M&A helps the company to grow in size along with strengthening management and financial condition of the companies.
- Companies get access to new markets, new customers, new products, new services and/or new geographic regions.
- May also help the companies gain a stronger foothold in the industry.
Generally it is observed that once a company matures or in competitive markets, it gets difficult for the company to achieve higher growth rates. In such situations, M&A helps the company to increase their growth rate through a variety of factors such as
- Acquiring new products of the target company
- Accessing new markets
- Capturing additional market share
- Accessing new customer base
The term synergy can be thought of as leveraging the combined strengths of two companies such that when two companies come together, their sum capabilities are more than their individual capabilities. Synergy is the most common reason why companies indulge in M&A. There are two forms of synergies –
- Operating Synergies
These synergies come from the combination or consolidation of two companies’ operations. Example –
a. Revenue Synergies – these come from various places such as cross selling one company’s products with another company’s customer base, etc.
b. Operating Expenses – there are many opportunities to reduce operating expenses in M&A. For example, no need for both the companies to have separate auditors, separate investor relations departments, etc.
2. Financial Synergies
These are thought of as enhancing the company’s financial structure, improve its ability to obtain financing on favorable terms, attracts investors, greater access to capital markets, etc.
It is an act of an existing company branching out into a new business opportunity which it does not already operate in. Many companies opt for M&A to diversify their business. Through M&A, a company gets easy access to another company’s products, customer base, etc. Company can add on new products or take over the existing products of the merging company and create profit.
- Enhance research, development and management efficiency
Many companies opt for M&A to enhance research and development. The most common example is of acquisitions done by pharmaceutical companies and technology industries to acquire newer technologies in order to produce better products for the consumers.
M&A takes place to integrate a company throughout its value chain. In simple words, a company may purchase or merge with a target company in order to capture a greater share of the overall dollar spent in a category. Integration may be done for capacity building, technology sharing, increasing market share and competitiveness, etc. There are two methods through which integration can take place-
- Vertical integration: Acquiring a company that operates in the production process of the same industry. Example – eBay and PayPal
- Horizontal integration: Acquiring a similar company in the same industry. Example – Facebook’s acquisition of Instagram
- Personal reasons such as greed, vanity and fear
Some M&A takes place due to sheer greed or vanity or fear of some key personnel managers in the company. There is ill motive behind this kind of M&A deal.
- Tax issues
A company with a large taxable income may look to merge with a company which has large carry-forward tax losses. By opting for such a deal, the acquiring company can lower its tax liabilities. However, such a merger will not be approved by regulators unless the company succeeds in hiding this reason with other strong motivations to merge.
- Other motives
Above mentioned motives are some of the common reasons why companies go for M&A. Some other motives may be –
- National champions – Companies within one nation such as European Union may wish to merge in order to become a national champion providing a particular kind of product or service. Government may approve of it as this will create larger domestic companies capable of competing in international markets.
- Internationalization/International Goals – Cross border mergers may be done in order to enhance customer base, diversify, wider outreach, etc.
- Unique capabilities – A company may acquire a target company to get access to the competencies and resources in which it (acquiring company) lacks.
NOTE – It is pertinent to remember that the above mentioned are the common reasons behind M&A. M&A takes place for a variety of reasons depending upon the needs of the parties to the deal. Most of the reasons why companies decide to merge are beneficial, or at least not harmful to the economy.
The above discussed is described in brief as follows –
Motives behind M&A
Gain scale and/or scope
A good M&A strategy is focused on gaining economies of scale or economies of scope in turn helping in the growth of the company by leaps and bounds. Various benefits –
M&A helps the company to increase their growth rate through a variety of factors such as –
The term synergy can be thought of as leveraging the combined strengths of two companies such that when two companies come together, their sum capabilities are more than their individual capabilities. Two types – Operating Synergies (Revenue Synergies, Operating expenses, etc.) and Financial Synergies
It is an act of an existing company branching out into a new business opportunity which it does not already operate in. Many companies opt for M&A to diversify their business.
Enhance research, development and management efficiency
Many companies opt for M&A to enhance research and development.
M&A takes place to integrate a company throughout its value chain. Two types – Vertical Integration and Horizontal Integration
Greed, vanity or fear
A company with a large taxable income may look to merge with a company which has large carry forward tax losses.
National champions, international goals, unique capabilities
It can be thus observed that there are various reasons for a company to go for a M&A deal. There may be one reason or multiple reasons combined behind a M&A. It is important to figure out the possible outcomes, both positive and negative before entering into M&A as, if not properly examined and evaluated, it may lead to huge losses, waste of time and resources.
- Richard Whish & David Bailey, Competition Law (8th ed. 2015).
- Peter A. Hunt, Structuring mergers & acquisitions: A Guide to Creating Shareholder Value (2nd ed. 2007).