If you’re in business, you may already have been involved in a merger (or an acquisition) (M&A). These transactions are popular ways for businesses to scale, rather than relying on organic growth.
If, however, you’re new to mergers and acquisitions the terminology can seem mystifying.
In this guide we look at the different type of merger, the upsides and downsides, and unpick the jargon.
We'll be covering:
- What is a merger?
- What’s the difference between a merger and an acquisition?
- Types of mergers and their advantages and disadvantages
- How does a strategic alliance differ from a merger?
- Key factors to consider in a merger
- How can companies choose the most suitable merger type for their goals and circumstances?
What is a merger?
A merger happens when two independent companies join to form a single business entity, often referred to ‘newco’. The staff, assets and liabilities of each merging business transfer to newco. The previous entities are then dissolved, and newco changes its name. It often keeps that of the more prominent business – for example, the merger of McDonnell Douglas with Boeing.
What’s the difference between a merger and an acquisition?
With an acquisition, one company buys another’s shares or assets. The company being bought frequently stays intact, becoming a subsidiary of the buyer. An example of an acquisition is the purchase of Android by Google.
The main differences between a merger and an acquisition, is that mergers are perceived as ‘friendly’ affairs of equal partners, much like a joint venture. The business affairs and operations of the two companies are gradually integrated after the merger – well-known examples are Exxon and Mobile, and Heinz and Kraft foods.
In contrast, acquisitions can sometimes be ‘hostile’, with an approach by a potential acquirer being unwelcome to the board of directors and/or shareholders of the target (known as a hostile takeover).
With private limited companies, it’s virtually impossible for one company to acquire another unless all parties are willing, however with public companies whose shares are openly traded, hostile takeovers are more common. One of the biggest hostile takeovers was the purchase of Warner Lambert by the pharmaceutical giant, Pfizer.
As mergers and acquisitions can often be quite complex, the term M&A is coming to mean any transaction where two businesses are consolidated.
For more information on this and other useful answers on M&A processes, read our Mergers & Acquisitions FAQs.
Types of mergers and their advantages and disadvantages
Here are the different types of mergers:
A horizontal merger is where two competitors combine. Each company benefits as they now have access to the other’s customers and can increase the range of products they offer.
This is why a horizontal merger is a good way to expand your market reach, break into new markets, and diversify your product range. By merging, you reduce the number of competing businesses so have greater control over the prices you charge to customers.
Because mergers of companies who are already dominant in their market can raise prices by eliminating competition (to the detriment of consumers) you should seek expert legal advice before this type of merger.
A vertical merger where a supplier buys a customer or vice versa. A key characteristic of vertical mergers is that they involve companies who already buy and/or sell to each other.
The benefit of a vertical merger is that the companies can combine their businesses to improve efficiency and reduce costs. For example, if a flour supplier merges with a bread making company, the merged entity will save money by paying less for flour, as well as saving on procurement costs, since the baker is tied to a single supplier.
As with horizontal mergers, vertical mergers can run into regulatory issues. If the merger reduces competition because the bread maker, in effect, forces the remaining flour suppliers out of business, the merger may not be allowed. Whether competition law applies to your merger will very much depend on the size and scale of your business, and the size of the affected market(s).
It can be tricky to make a success of vertical mergers, as the merged businesses can be so different in nature that it’s difficult for management to run them side by side without reducing quality.
A congeneric merger is where two businesses have the same customer base, but each provides different type of products or services. For example, a TV manufacturer and a cable company.
The benefit of a congeneric mergers is that the businesses can take advantage of their increased access to the customers of the other.
If this is an option for you, make sure that the companies are compatible. Is this a good cultural fit? If not, a short- to medium-term drop in productivity is likely.
A market-extension merger involves a combination of two companies that sell the same products in different markets. An example would be a merger of a UK software company with a foreign software company.
The benefit of this type of merger is each business gains access to new customers and territories. The potential downsides are like those with other mergers – it can be difficult to manage and coordinate separate operations, and cultural fit can cause problems and reduce productivity.
This is where two businesses sell different but related products in the same market. For example, your company makes laptops, and the other company makes computer chips. Both products are distinct and different, but they fall within the same category.
The benefit of this merger is that you can offer more products and/or services to customers, thereby expanding your business and increasing profitability.
However, there are disadvantages – management and operational difficulties and cultural conflict can undermine the productivity of the merged entity.
A conglomerate merger where two companies that serve completely different markets join forces.
This transaction enables each company to expand their services by reaching into a new market sector, benefitting from the expertise of the other and gaining a competitive edge.
Plus, the companies involved in a conglomerate merger can reduce risk. For example, if you sell clothes and that market is struggling, and you merge with a supermarket whose market is buoyant, you can reduce your market exposure by combining operations.
If you do consider a conglomerate merger, make sure you don’t overreach, particularly if you lack experience in the sector/industry of the target. There are additional downsides, as with other mergers, such as cultural differences, that can cause a dip in productivity.
A reverse merger is when a private company acquires a public company, to become publicly listed. Although the main way to become public is to make an initial public offering, it’s often quicker for a private company to become public by reverse merger.
As with traditional acquisitions, a reverse merger allows your business to grow and reach new markets, increasing profitability and elevating your brand, as public companies are viewed as being more established.
The disadvantage of a reverse merger is that it’s a risky way to become public, as the company being acquired may have undisclosed risks and liabilities such as unpaid debts and litigation.
In addition, you may not be ready to go public, particularly if you’re unfamiliar with the rules and regulations that public companies are bound by. Lastly, this can be an expensive route to becoming public, as in addition to funds for the purchase, you’ll need enough cash to continue operating.
How does a strategic alliance differ from a merger?
Unlike a merger or a joint venture, companies may form strategic alliances to profit from certain synergies (access to the other’s customers, for example, but without formally deciding to combine their businesses. This is frequent with airlines, for example.
In this way, the two business can join forces to achieve a certain goal or project, improve their respective images or access to resources but without the formal commitment that a JV or merger involves.
Key factors to consider in a merger
So, how do you know if a merger is right for you, and what are the most important things to think about if a merger is on the cards?
Firstly, you need to pick the right partner. Remember, mergers are consensual affairs, and unless you truly believe in the deal and trust each other to make it a success, the cost of failure is high. Communicate your goals, fears and expectations and move forward together.
Good due diligence in a merger or acquisition is a must. Get to know your partner and allow them equal access to your books and records. Work towards a meeting of minds on the valuation of each company. Make sure you’re on top of the legal and regulatory hurdles so that you can build potential delays into the plan.
Keep staff involved and informed at all stages. Unless you bring your team with you, they won’t have confidence in the deal. Make sure there’s an excellent strategic and cultural fit.
Have a clear plan of action, and make sure you keep moving forward. A stalled plan can quickly backfire as each side loses momentum. Develop a communication strategy that dovetails with the legal stages of the deal.
Make sure you know exactly how you will benefit from the deal and execute your cost-saving ideas as soon as possible.
How can companies choose the most suitable merger type for their goals and circumstances?
The simplest way to choose the best merger type for your business goals is to read this guide to understand the different options available, and then ask yourself whether the potential benefits on offer outweigh the inevitable drag on productivity and profit. Make sure you pick the right partner whose goals and culture best aligns with your own, and make sure you communicate with your team at each step of the way.
For more answers to commonly asked questions and advice on mergers and acquisitions, consult our mergers and acquisitions solicitors. Get in touch on 0800 689 1700, email us at firstname.lastname@example.org, or fill out the short form below with your enquiry.