Unit -5: Mergers and acquisition

Mergers and acquisitions, or M&A for short, involves the process of combining
two companies into one. The goal of combining two or more businesses is to try
and achieve synergy – where the whole (new company) is greater than the sum of
its parts (the former two separate entities).

Mergers occur when two companies join forces. Such transactions typically happen
between two businesses that are about the same size and which recognize
advantages the other offers in terms of increasing sales, efficiencies, and
capabilities. The terms of the merger are often fairly friendly and mutually agreed
to and the two companies become equal partners in the new venture.

Acquisitions occur when one company buys another company and folds it into its
operations. Sometimes the purchase is friendly and sometimes it is hostile,
depending on whether the company being acquired believes it is better off as an
operating unit of a larger venture.

The end result of both processes is the same, but the relationship between the two
companies differs based on whether a merger or acquisition occurred.
Horizontal Mergers

A merger occurring between companies in the same industry. Horizontal merger is

a business consolidation that occurs between firms who operate in the same space,
often as competitors offering the same good or service. Horizontal mergers are
common in industries with fewer firms, as competition tends to be higher and the
synergies and potential gains in market share are much greater for merging firms in
such an industry.
Example

A merger between Coca-Cola and the Pepsi beverage division, for example, would
be horizontal in nature. The goal of a horizontal merger is to create a new, larger
organization with more market share. Because the merging companies' business
operations may be very similar, there may be opportunities to join certain
operations, such as manufacturing, and reduce costs. The benefit of this kind of
merger is that it eliminates competition, which helps the company to increase its
market share, revenues and profits. Moreover, it also offers economies of scale due
to increase in size as average cost decline due to higher production volume. These
kinds of merger also encourage cost efficiency, since redundant and wasteful
activities are removed from the operations i.e. various administrative departments
or departments such as advertising, purchasing and marketing.

Vertical Mergers

A merger between two companies producing different goods or services for one
specific finished product. A vertical merger occurs when two or more firms,
operating at different levels within an industry's supply chain, merge operations.
Most often the logic behind the merger is to increase synergies created by merging
firms that would be more efficient operating as one.
Examples of a Vertical Merger
An example of a vertical merger is a car manufacturer purchasing a tire company.
Such a vertical merger reduces the cost of tires for the automaker and potentially
expands its business by allowing it to supply tires to competing automakers. This
example shows how a vertical merger can be twice as beneficial to the company
conducting the integration. Initially, the firm benefits from reduced costs, which
lead to increased profits. Vertical mergers also offer cost saving and a higher
margin of profit, since manufacturer’s share is eliminated.

Concentric Mergers
Concentric mergers take place between firms that serve the same customers in a
particular industry, but they don’t offer the same products and services. Their
products may be complements, product which go together, but technically not the
same products.
For example, if a company that produces DVDs mergers with a company that
produces DVD players, this would be termed as concentric merger, since DVD
players and DVDs are complements products, which are usually purchased
together. These are usually undertaken to facilitate consumers, since it would be
easier to sell these products together. Also, this would help the company diversify,
hence higher profits. Selling one of the products will also encourage the sale of the
other, hence more revenues for the company if it manages to increase the sale of
one of its product. This would enable business to offer one-stop shopping, and
therefore, convenience for consumers. The two companies in this case are
associated in some way or the other. Usually they have the production process,
business markets or the basic technology in common. It also includes extension of
certain product lines. These kinds of mergers offer opportunities for businesses to
venture into other areas of the industry reduce risk and provide access to resources
and markets unavailable previously.

Conglomerate Merger
When two companies that operates in completely different industry, regardless of
the stage of production, a merger between both companies is known as
conglomerate merger. This is usually done to diversify into other industries, which
helps reduce risks.
In other words A merger between firms that are involved in totally unrelated
business activities. There are two types of conglomerate mergers: pure and mixed.
Pure conglomerate mergers involve firms with nothing in common, while mixed
conglomerate mergers involve firms that are looking for product extensions or
market extensions.

Example

A leading manufacturer of athletic shoes, merges with a soft drink firm. The
resulting company is faced with the same competition in each of its two markets
after the merger as the individual firms were before the merger. One example of a
conglomerate merger was the merger between the Walt Disney Company and the
American Broadcasting Company.
Market Extension Mergers

A market extension merger takes place between two companies that deal in the
same products but in separate markets. The main purpose of the market extension
merger is to make sure that the merging companies can get access to a bigger
market and that ensures a bigger client base.
Example

is when a national company mergers with a locally based company.

The goal of the market extension merger is to gain access to a larger market and
therefore, a greater client base. It is critical, however, that the right business partner
be identified if you are considering a market extension merger. When a local
company merges with a larger, national company, the clash in business cultures
can negatively impact the company’s success. In addition, what made the local
company successful in the first place may become too diluted after a merger with a
larger, national organization.

Product Extension Mergers

A product extension merger takes place between two business organizations that
deal in products that are related to each other and operate in the same market. The
product extension merger allows the merging companies to group together their
products and get access to a bigger set of consumers. This ensures that they earn
higher profits.

Example

An example would be a company manufacturing laptops, and a company which

manufactures portable hard disks. Both products are distinct and different, but they
fall within the same category of computers.

The benefit of this merger is that it allows you to offer more products and/or
services to customers, thereby expanding your business and increasing your
profitability.
Vertical Merger

A merger between two companies producing different goods or services for one
specific finished product. A vertical merger occurs when two or more firms,
operating at different levels within an industry's supply chain, merge operations.
Most often the logic behind the merger is to increase synergies created by merging
firms that would be more efficient operating as one.

Example

A vertical merger joins two companies that may not compete with each other, but
exist in the same supply chain. An automobile company joining with a parts
supplier would be an example of a vertical merger. Such a deal would allow the
automobile division to obtain better pricing on parts and have better control over
the manufacturing process. The parts division, in turn, would be guaranteed a
steady stream of business.
Synergy, the idea that the value and performance of two companies combined will
be greater than the sum of the separate individual parts is one of the reasons
companies merger.

Forward merger: In a forward merger, the target merges into the buyer. For e.g.,
when ICICI Bank acquired Bank of Madura, Bank of Madura which was the target,
merged with the acquirer, ICICI Bank.

Reverse merger: In this case, the buyer merges into the target and the shareholders
of the buyer get stock in the target. This is treated as a stock acquisition by the
buyer.

Subsidiary merger: A subsidiary merger is said to occur when the buyer sets up an
acquisition subsidiary which merges into the target.

Types of Acquisitions
There are several types of acquisitions:

Types of Acquisition:
 Friendly Acquisition:

In a friendly takeover, there is an agreement between the target company and the
acquiring company. The acquiring company takes over a company by negotiating
terms with management. The acquiring company offers the target company which
is accepted by the target company. This type of acquisition is generally done for
the mutual benefit of both companies.

Hostile Acquisition:
• Unlike a friendly takeover, there is no agreement in a hostile takeover. The
acquiring company takes over a company by going directly to company
shareholders. The acquiring company secretly acquires the target company.
Generally, in this kind of take over, there is no or little mutual benefit. This kind of
takeover takes place when the target companies do not agree or gives its consent to
the acquisition. Majority stake or ownership is taken secretly to force the
acquisition.

• Buyout takeover. The acquiring company takes over a company by buying more
than 50% of the company

Motives/ reasons for Mergers and Acquisitions

Mergers and acquisitions are strategic decisions leading to the maximization of a

company’s growth by enhancing its production and marketing operations. They
have become popular in the recent times because of the enhanced competition,
breaking of trade barriers, free flow of capital across countries and globalization of
business as a number of economies are being deregulated and integrated with other
economies. A number of motives are attributed for the occurrence of mergers and
acquisitions.

In this section, we consider a number of different motives for mergers and

acquisitions.
1. Synergies through Consolidation
Synergy implies a situation where the combined firm is more valuable than the
sum of the individual combining firms. It is defined as ‘two plus two equal to five’
(2+2=5) phenomenon. Synergy refers to benefits other than those related to
 economies of scale. Operating economies are one form of synergy benefits. But
apart from operating economies, synergy may also arise from enhanced managerial
capabilities, creativity, innovativeness, R&D and market coverage capacity due to
the complementarily of resources and skills and a widened horizon of
opportunities.
An under valued firm will be a target for acquisition by other firms. However, the
fundamental motive for the acquiring firm to takeover a target firm may be the
desire to increase the wealth of the shareholders of the acquiring firm. This is
possible only if the value of the new firm is expected to be more than the sum of
individual value of the target firm and the acquiring firm. For example, if A Ltd.
and Ltd. decide to merge into AB Ltd. then the merger is beneficial if
V (AB)> V (A) +V (B)
Where,

• V (AB) = Value of the merged entity

• V (A) = Independent value of company A
• V (B) = Independent value of company B

2. Diversification
A commonly stated motive for mergers and acquisitions is to achieve risk
reduction through diversification. The extent, to which risk is reduced, depends
upon on the correlation between the earnings of the merging entities. While
negative correlation brings greater reduction in risk, positive correlation brings
lesser reduction in risk. If investors can diversify on their own by buying stocks of
companies which propose to merge, they do not derive any benefits from the
proposed merger. Any investor who wants to reduce risk by diversifying between
two companies, say, ABC Company and PQR Company, may simply buy the
stocks of these two companies and merge them into a portfolio. The merger of
these companies is not necessary for him to enjoy the benefits of diversification.
As a matter of fact, his ‘home-made diversification give him far greater flexibility.
He can contribute the stocks of ABC Company and PQR Company in any
proportion he likes as he is not confronted with a ‘fixed’ proportion that result
from the merger.
Thus, Diversification into new areas and new products can also be a motive for a
firm to merge another with it. A firm operating in North India, if merges with
another firm operating primarily in South India, can definitely cover broader
economic areas. Individually these firms could serve only a limited area.
 Moreover, products diversification resulting from merger can also help the new
firm fighting the cyclical/seasonal fluctuations. For example, firm A has a product
line with a particular cyclical variations and firm B deals in product line with
counter cyclical variations. Individually, the earnings of the two firms may
fluctuate in line with the cyclical variations. However, if they merge, the cyclically
prone earnings of firm A would be set off by the counter cyclically prone earnings
of firm B. Smoothing out the earnings of a firm over the different phases of a cycle
tends to reduce the risk associated with the firm.
Through the diversification effects, merger can produce benefits to all firms by
reducing the variability of firm’s earnings. If firm A’s income generally rises when
B’s income generally falls, and vice-a versa, the fluctuation of one will tend to set
off the fluctuations of the other, thus producing a relatively level pattern of
combined earnings. Indeed, there will be some diversification effect as long as the
two firm’s earnings are not perfectly correlated (both rising and falling together).
This reduction in overall risk is particularly likely if the merged firms are in
different lines of business.
The diversification motive is based on the proposition that if two risky projects are
combined, then the risk of combination will be less than the weighted average of
the risk of these two projects. The greatest benefit from diversification can be
obtained by continuing firms from different industries i.e., conglomerate mergers;
where two firms poorly correlated cash flows merged to create a portfolio of a
firms. But portfolio of firms in a conglomerate merger is costly as the acquisition
of firms is a costly exercise. On the other hand, a shareholder can easily create a
diversified portfolio of firms merely by holding the shares of diversified
companies. This is much easier and cheaper than creating a portfolio of firms in
conglomerate merger.
Thus, firms diversify to achieve:

• Sales and growth stability

• Favorable growth developments
• Favorable competition shifts
• Technological changes

3. Accelerated Growth
Growth is essential for sustaining the viability, dynamism and value-enhancing
capability of company. A growth- oriented company is not only able to attract the
most talented executives but it would also be able to retain them. Growing
operations provide challenges and excitement to the executives as well as
 opportunities for their job enrichment and rapid career development. This helps to
increase managerial efficiency. Other things being the same, growth leads to higher
profits and increase in the shareholders value. A company can achieve its growth
objective by:

• Expanding its existing markets

• Entering in new markets.

A company may expand and/or diversify its markets internally or externally. If the
company cannot grow internally due to lack of physical and managerial resources,
it can grow externally by combining its operations with other companies through
mergers and acquisitions. Mergers and acquisitions may help to accelerate the pace
of a company’s growth in a convenient and inexpensive manner.
Internal growth requires that the company should develop its operating facilities-
manufacturing, research, marketing etc. Internal development of facilities for
growth also requires time. Thus, lack or inadequacy of resources and time needed
for internal development constrains a company’s pace of growth. The company can
acquire production facilities as well as other resources from outside through
mergers and acquisitions. Specially, for entering in new products/markets, the
company may lack technical skills and may require special marketing skills and/or
a wide distribution network to access different segments of markets. The company
can acquire existing company or companies with requisite infrastructure and skills
and grow quickly.
Mergers and acquisitions, however, involve cost. External growth could be
expensive if the company pays an excessive price for merger. Benefits should
exceed the cost of acquisition for realizing a growth which adds value to
shareholders. In practice, it has been found that the management of a number of
acquiring companies paid an excessive price for acquisition to satisfy their urge for
high growth and large size of their companies. It is necessary that price may be
carefully determined and negotiated so that merger enhances the value of
shareholders.
For example, RPG Group had a turnover of only Rs.80 crores in 1979. This has
increased to about Rs. 5600 crores in 1996. This phenomenal growth was due to
the acquisitions of a several companies by the RPG Group. Some of the companies
acquired are Asian cables, ceat, Calcutta Electricity Supply and company, SAE etc.
4. Increased Market Power
A merger can increase the market share of the merged firm. The increased
concentration or market share improves the profitability of the firm due to
economies of scale. The bargaining power of the firm with labour, suppliers and
buyers is also enhanced. The merged firm can also exploit technological
breakthroughs against obsolescence and price wars. Thus, by limiting competition,
the merged firm can earn super normal profit and strategically employ the surplus
funds to further consolidate its position and improve its market power.
The acquisition of Universal Luggage by Blow Plast is an example of limiting
competition to increase market power. Before the merger, the two companies were
competing fiercely with each other leading to a severe price war and increased
marketing costs. As a result of the merger, Blow Plast has obtained a strong hold
on the market and now operates under near monopoly situation. Yet another
example is the acquisition of Tomco by Hindustan Lever. Hindustan Lever at the
time of merger was expected to control one-third of three million tonne soaps and
detergents markets and thus, substantially reduce the threat of competition.
Merger is not only route to obtain market power. A firm can increase its market
share through internal growth or ventures or strategic alliances. Also, it is not
necessary that the increased market power of the merged firm will lead to
efficiency and optimum allocation of resources. Market power means undue
concentration which could limit the choice of buyers as well as exploit suppliers
and labor.
5. Purchase of Assets at Bargain Price
Mergers may be explained by the opportunity to acquire assets, particularly land,
mined rights, plant and equipment at lower cost than would be incurred if they
were purchased or constructed at current market prices. If market prices of many
stocks have been considerably below the replacement cost of the assets they
represent, expanding firm considering constructing plants developing mines, or
buying equipment. Often it has found that the desired asset could be obtained
cheaper by acquiring a firm that already owned and operated the asset. Risk could
be reduced because the assets were already in place and an organization of people
knew how to operate them and market their products.
Many of mergers can be financed by cash tender offers to the acquired firm’s
shareholders at price substantially above the current market. Even, so, the assets
can be acquired for less than their current cost of construction. The basic factor
underlying this is that inflation in construction costs not fully reflected in stock
prices because of high interest rates and limited optimism (or downright
pessimism) by stock investors regarding future economic conditions.
6. Increased External Financial Capability
Many mergers, particularly those of relatively small firms into large ones, occur
when the acquired firm simply cannot finance its operations. This situation is
typical in a small growing firm with expanding financial requirements. The firm
has exhausted its bank credit and has virtually no access to long term debt or equity
markets. Sometimes the small firms have encountered operating difficulty and the
bank has served notice that its loans will not be renewed. In this type of situation, a
large firm with sufficient cash and credit to finance the requirements of the smaller
one probably can obtain a good situation by making a merger proposal to the small
firm. The only alternative the small firm may have is to try to interest two or more
larger firms in proposing merger to introduce completion into their bidding for the
acquisition.
The smaller firm’s situation might not be so bleak. It may not be threatened by
nonrenewable of a maturing loan. But its management may recognize that
continued growth to capitalize on its markets will require financing beyond its
means. Although its bargaining position will be better, the financial synergy of the
acquiring firm’s strong financial capability may provide the impetus for the
merger.
Sometimes the financing capability is possessed by the acquired firm. The
acquisition of a cash rich firm whose operations have matured may provide
additional financing to facilitate growth of the acquiring firm. In some cases, the
acquiring firm may be able to recover all or part of the cost of acquiring the cash-
rich firm when the merger is consummated and the cash then belongs to it.
A merger also may be based upon the simple fact that the combination will make
two small firms with limited access to capital markets large enough to achieve that
access on a reasonable basis. The improved financing capability provides the
financial synergy.
7. Economies of Scale:
An amalgamated company will have more resources at its command than the
individual companies. This will help in increasing the scale of operations and the
economies of large scale will be availed. These economies will occur because of
more intensive utilization of production facilities, distribution network, research
and development facilities, etc.
These economies will be available in horizontal mergers (companies dealing in
same line of products) where scope of more intensive use of resources is greater.

The economies will occur only up to a certain point of operations known as

optimal point. It is a point where average costs are minimum. When production
increases from this point, the cost per unit will go up.

8. Operating Economies:
A number of operating economies will be available with the merger of two or more
companies. Duplicating facilities in accounting, purchasing, marketing, etc. will be
eliminated. Operating inefficiencies of small concerns will be controlled by the
superior management emerging from the amalgamation. The amalgamated
companies will be in a better position to operate than the amalgamating companies
individually.

9. Utilization of Tax Shields:

When a company with accumulated losses merges with a profit making company it
is able to utilize tax shields. A company having losses will not be able to set off
losses against future profits, because it is not a profit earning unit.

On the other hand if it merges with a concern earning profits then the accumulated
losses of one unit will be set off against the future profits of the other unit. In this
way the merger or amalgamation will enable the concern to avail tax benefits.

10. Eliminations of Competition:

The merger or amalgamation of two or more companies will eliminate competition
among them. The companies will be able to save their advertising expenses thus
enabling them to reduce their prices. The consumers will also benefit in the form of
cheap or goods being made available to them.

11. Better Financial Planning:

The merged companies will be able to plan their resources in a better way. The
collective finances of merged companies will be more and their utilisation may be
better than in the separate concerns. It may happen that one of the merging
companies has short gestation period while the other has longer gestation period.
The profits of the company with short gestation period will be utilised to finance
the other company. When the company with longer gestation period starts earning
profits then it will improve financial position as a whole.

12. Economic Necessity:

Economic necessity may force the merger of some units. If there are two sick units,
government may force their merger to improve their financial position and overall
working. A sick unit may be required to merge with a healthy unit to ensure better
utilization of resources, improve returns and better management. Rehabilitation of
sick units is a social necessity because their closure may result in unemployment
etc.

Benefits of mergers and acquisition

Note: Points can be taken from reasons from merger and acquisition too;
those points can be written as advantages for mergers and acquisitions

Here are many advantages of growing your business through an acquisition or

merger. These include:

1. Mergers and acquisitions can come with various tax advantages

Many governments offer tax cuts or reductions when a merger or acquisition is

completed. Among these, Singapore is one of the best Asian countries where a
merger or acquisition could take place in. Opening a business in Singapore by
merging or acquiring a smaller existing company can attract substantial tax
advantages in this country.

2. New possibilities offered by a new market

One of the greatest struggles a business owner can face is related to entering a new
market. Even if setting up a branch or subsidiary is a good idea; a merger or
acquisition will save time and money spent on starting a business from scratch.
Imagine wanting to enter the Dutch market: there are so many small companies
operating in the Netherlands and many of them can be purchased and expanded in
a market in which they already have their own share of loyal customers. As a
bonus, the foreign business owner will also be entitled to obtain a Dutch residence
permit and that allows a move to one of the greatest countries in Europe. An
experienced immigration lawyer in the Netherlands can help foreign investors
obtain a Dutch residence permit.

3. Obtaining easier access to a skilled labor force

One of the conditions for merging with or acquiring another company is to retain
the staff and integrate them in the new company. These are legal requirements
imposed by national and international regulations. The UAE is one of the countries
which have imposed strict regulations related to international mergers and
acquisitions. The good news is that if you plan on starting a company in Dubai by
taking over another business, you will benefit from skilled and English-speaking
employees as most workers there speak English.

4. You can diversify your portfolio

One of the most important advantages offered by mergers and acquisitions is

related to a wider range of services or products which can be explored. By joining
forces, the portfolio of the new business can increase even more and gain access to
a larger market share. This is usually the case of IT companies in which innovation
plays a key role. Taking over a Hong Kong company could be a very good idea
when talking about innovation and international IT centers.

5. Buying or merging with another company is usually cheaper

Building production centers, storage, and distribution facilities are all quite
expensive, but buying or merging with a company, even if from another country,
which already has such facilities, will turn out way cheaper than building new
ones. One of the cheapest Asian destinations from this point of view is
Malaysia. Setting up a business in Malaysia by buying an existing company which
has such facilities can mean a significant economy related to the expansion costs.

6. Better access to a larger market

Back to the market share, small countries make great development markets for
companies. As a matter of fact, the smaller the country the larger the access to its
market will be by taking over a company there. Ireland is one of the best countries
to do that. Establishing a business in Ireland by taking over small but well-known
companies is quite often met.
7. Mergers and acquisitions can mean greater financial power and more
influence

Mergers and acquisitions represent growth for both companies involved in the
transaction. Moreover, it will mean more financial power as the revenue generated
by pooling the incomes of both businesses. As a chain reaction, having a greater
financial power will also mean occupying a larger share of the market and having
more influence over the customers by reducing the competition.

Mergers and acquisitions have many benefits and we have only analyzed a few of
them. Being very well regulated, these types of actions will definitely attract more
advantages depending on what the companies undergoing the taking-over follow
and what they negotiate. A major requirement for business loans is revenue thus
the higher revenue resulting from the merger creates a positive cash flow and credit
scenario for companies. This allows the merged company to grow faster with
capital investment for development, marketing and talent.

8. Penetrate a New Market

Successful businesses have identified a need in a market and they need to fulfill
that need. A similar business that wants to build its market share benefit in a
merger. Penetrating a new market includes gaining a new geographical area or a
specific niche in an industry.
For example, a successful European technology company might merge with a
similar North American company so that they may gain access to the American
market. This strategy works on a large international scale and also on a small
community scale. A sandwich shop might merge with another sandwich shop in a
neighboring town to establish a chain and to build a larger brand.

9. Better Fulfill Consumer Needs

Business leaders always need to consider the consumer's experience with the
company and its products or services. A merger should function to better serve the
existing customer base of the companies. Many banks have merged with
investment services companies to broaden the financial services available to
customers.
An example of this is Bank of America merging with Merrill Lynch. This type of
merger takes companies that target the same clients but offer non-competing
services, giving customers a one-stop-shopping experience with credible services.

10. Product Innovation and Development

Product development is expensive and risky. In a merger scenario, the larger
company should have a higher valuation and be better positioned to develop new
products. This is common in the pharmaceutical industry where small start-ups
developing one or two new products are unable to fund research, testing and
regulatory compliance over extended time frames.
By merging, the smaller company benefits from the research and finances of the
larger company to continue to develop new items. The larger company benefits
from getting developed products that have already met the desired level of success.

11. Key Personnel and Talent

Two companies might merge so that they get the benefit of leadership of key
individuals in the company. A small Smartphone game-development company
might find itself wildly successful beyond expectations and it might feel
unprepared to continue to serve such a large market. Merging with another
company that understands how to capitalize on growing success gives the smaller
company the ability to grow successfully and to continue to deliver products
without problems.
Some mergers, such as the one between AOL and Time-Warner, sought to obtain
industry insight from key people within each of the companies so that it could
develop a larger company capable of succeeding in a new digital entertainment
marketplace.

MERGERS VS ACQUISITIONS
The following are the differences between mergers and acquisitions:
DEFINITION
The fusion of two or more entities taking place voluntarily to form a new entity is
termed as a merger. While one company purchasing the business of another
company is known as an acquisition.

PRESENCE
The companies involved in the merger dissolve to form a new entity. While in an
acquisition, both the companies do not lose their existence.

TITLE
The new entity formed owing to the merger, holds a new title. In an acquisition,
the acquired company functions under the title of the acquiring company.
TERMS
Merger is always conducted under a mutual agreement by all the involved
companies. An acquisition may be implemented voluntarily or involuntarily by the
entities.
SIZE OF OPERATIONS
Two or more companies having the same scale of operations opt for a merger.
Whereas, in an acquisition the larger company takes over the smaller company.

LEGALITIES
The process of merger involves a time consuming procedure owing to the high
number of legal formalities. As opposed to an acquisition which can be done faster
as the legal formalities are minimal.

PURPOSE
The purpose of merging entities is to decrease the prevailing competition in the
market and to increase operational efficiency. However, the sole purpose of an
acquisition is an expansion of the entity.

POWER
In a merger, both the companies involved are treated as equal. Whereas in an
acquisition, the stronger company holds complete control and power.

STOCKS
A merger leads to issue of new stocks. While in an acquisition, no new stocks are
issued.
MANAGEMENT
The ownership and management structure of the new entity remains almost similar
to the previous two entities. In an acquisition, the acquiring company owns the
management of the entire organization.

Conclusion
In the fast-paced corporate world, mergers are occasionally seen. However,
extreme competition prevailing in the market leads to a number of acquisitions.
The companies involved in mergers and acquisitions gain the advantage of
financial benefit, synergy, taxation and increase in competitiveness. However,
adverse effects such as clash in the culture of the entities and increase in employee
turnover are also noted.

Process of Merger and Acquisition

Merger and acquisition process is the most

challenging and most critical one when it
comes to corporate restructuring. One wrong
decision or one wrong move can actually
reverse the effects in an unimaginable manner.
It should certainly be followed in a way that a
company can gain maximum benefits with the
deal.

Following are some of the important steps in

the M&A process:

Business Valuation
Business valuation or assessment is the first
process of merger and acquisition. This step
includes examination and evaluation of both the
present and future market value of the target
company. A thorough research is done on the
history of the company with regards to capital
gains, organizational structure, market share,
distribution channel, corporate culture, specific
business strengths, and credibility in the
market. There are many other aspects that
should be considered to ensure if a proposed
company is right or not for a successful
merger.

Proposal Phase
Proposal phase is a phase in which the company
sends a proposal for a merger or an acquisition
with complete details of the deal including the
strategies, amount, and the commitments. Most
of the time, this proposal is send through a non-
binding offer document.

Planning Exit
When any company decides to sell its
operations, it has to undergo the stage of exit
planning. The company has to take firm
decision as to when and how to make the exit in
an organized and profitable manner. In the
process the management has to evaluate all
financial and other business issues like taking a
decision of full sale or partial sale along with
evaluating on various options of reinvestments.

Structuring Business Deal

After finalizing the merger and the exit plans,
the new entity or the takeover company has to
take initiatives for marketing and create
innovative strategies to enhance business and
its credibility. The entire phase emphasize on
structuring of the business deal.

Stage of Integration
This stage includes both the company coming
together with their own parameters. It includes
the entire process of preparing the document,
signing the agreement, and negotiating the deal.
It also defines the parameters of the future
relationship between the two.

Operating the Venture

After signing the agreement and entering into
the venture, it is equally important to operate
 the venture. This operation is attributed to meet
the said and pre-defined expectations of all the
companies involved in the process. The M&A
transaction after the deal include all the
essential measures and activities that work to
fulfill the requirements and desires of the
companies involved.

The Procedure of Acquisition:

1. Researching Target Companies:

Before acquiring any company detailed research about the company is necessary
which will avoid the problems in the future. A matrix of the company should be
made regarding the profitability, cash flow, growth rate etc. Research should be
done through various sources.

2. Initial Contact:

After the research has been completed the acquiring company should contact the
target company so that many issues can be clarified which would take place in the
future. Contact can be made through the following ways:

• Discrete contact: In this type direct contact is made with the owner of the
target company. This process can take several days or months. It is not
necessary that it may affect the immediate acquisition.

• Joint Venture: It is one of the best methods to enter into a joint venture
agreement with the target company. This agreement will give detailed
information about the company’s activity and operational detail. This
detailed information will help the acquirer to deal with the target company.

• Third party: There may be situations when the target company does not
want to give any information to any other company regarding its business, In
this case the acquirer company can appoint an investment banker who will
work on the behalf of the acquirer company in taking general inquiries of the
target company regarding the willingness of the owner about the acquisition.

3. Non- Disclosure Agreements:

This agreement is entered between the Acquirer Company and the Target
Company. This agreement can be entered only after the target company has
approved the offer of acquisition. In this agreement, it is stated that all the
documents or information disclosed by the target company to the acquirer
company shall remain confidential and will not be disclosed to anyone. However
this agreement is difficult is to enforce but on the other hand, it is necessary to be
entered.

4. Letter of Intent:

As soon as the acquirer company and the target company sign the Non-Disclosure
Agreement the target company will transfer all the documents, historical
background and detailed information to the acquirer company based on which the
acquirer company can take the decision to whether proceed with the deal or not.

5. Due Diligence:

In this step, the acquirer company shall give a list of due diligence to the target
company. This process may take a considerable amount of time as the documents
may not be easily available with the target company as it may not be prepared for
selling itself. Audited financial statements will help a lot as it will depict the true
financial position of the company.

6. Final Negotiations:

After the due diligence has been completed it may be possible that the acquirer
company may be in a position to do bargaining or negotiation in relation to the
price demanded by the target company for the acquisition. As the process of due
diligence will help in finding any major issues which will help in bargaining.
MERGERS AND ACQUISITIONS: VALUATION METHODS

Generally, when valuing a company, there are two different ways to approach the
valuation of the company: the first is the liquidation value of the company, and the
second is the value of the company as a going concern. Most often in a mergers
and acquisitions transaction, the target business will be valued as a going concern,
unless the target company is in distress and the acquiring company is purchasing it
to strip it down and sell the assets, or to remove it from the market as a
competitor. The liquidation value is most accurate for distressed companies, or
companies that require restructuring. When a company is valued as a going
concern, the assumption is made that the company will continue operating
throughout the foreseeable future, adding to its value beyond just the sum of its
assets.

When undergoing valuations for companies that are being valued as a going
concern, the acquiring company will be looking at the earning power of the
business, as well the cash generation capability of all of the assets that make up the
operations of the target company. When the target company is valued as a going
concern, rather than through liquidation value, non-operating or intangible assets
will be included in the valuation, including such items as: brands, trademarks,
patents, interests in other companies, customer and supplier relations, skill of
management and expertise, technology, industry know-how, infrastructure, etc.

The following will include some of the ways to approach valuations in the mergers
and acquisitions setting, as well as some of their strengths and weaknesses.

Price-Earnings Ratio (P/E Ratio)

The P/E Ratio is the comparison of the company’s current share price to its per-
share earnings. The P/E Ratio is expressed as follows: Market Value per Share /
Earnings per Share (EPS). Usually, the EPS is calculated from the last four
quarters of the company’s performance, but can also be calculated by estimating
the company’s earnings over the next four quarters, or a combination of the
previous two quarters and the estimates for the next two quarters.

A higher P/E ratio signals an expectation by investors for a high earnings growth in
the future compared to those companies that have a lower P/E ratio. In a mergers
and acquisitions transaction, when valuing a company’s P/E Ratio, it is most useful
to compare to the ratios of companies in the same industry, or against the
company’s historical P/E Ratio. The P/E Ratio also signals how much investors
are willing to pay per dollar of earnings. P/E Ratios can be easily manipulated via
a company’s accounting practices however, so it is important to not depend on this
method alone.

Enterprise-Value-to-Sales Ratio (EV/Sales)

This ratio is a valuation measure comparing a company’s enterprise value to the

sales of a company. This ratio is used by investors in a mergers and acquisitions
transaction to get a base estimate of the price it would cost to buy the company’s
sales, and generally, the lower the EV to Sales ratio is the more attractive or
undervalued the company is believed to be by possible acquiring parties. A
company can essentially be bought by its own cash if the EV/Sales measure is
negative – meaning that the cash in the company is greater than the market
capitalization and debt structure. EV/Sales is often more accurate than the price-
to-sales valuation method (which uses the market capitalization rather than the
enterprise value of the company), due to the fact that market capitalization does not
incorporate the level of debt a company has as well as the enterprise value of the
company does. EV/Sales measurements are not always telling of the company’s
position, however, as a high ratio could mean that investors believe future sales
could greatly increase, and a lower ratio may even signal unattractive future sales
prospects.

The EV/Sales Ratio equation is expressed as follows:

(Market Capitalization + Debt + Preferred Shares – Cash and Cash Equivalents) /

Annual Sales

Book Value

Valuation based off of the book value method works best for those firms that do
not have intangible assets, and important assets such as intellectual property, trade
secrets, brand value, and the competency of the managers and officers are ignored
in the valuation. The book value will also depend on which of the varying
accounting practices the company uses. Liabilities are often in dispute when
negotiating a valuation in a mergers and acquisitions transaction when using book
value.
Liquidation Value

Liquidation value is the value of the sale of assets at a certain point in time via the
use of an appraiser or appraisers. Usually this method will be utilized for firms in
financial distress, or have an uncertain future. Often, it is difficult to get a
consensus between the parties as liquidation values tend fluctuate with the
appraiser, and such factors need to be taken into consideration such as the physical
condition of the assets, or in some cases, the age of the assets. Furthermore, some
appraisers may ignore the value of certain intangible assets.

Market Value (of Securities)

The market value of traded securities is most often used to assess the value of the
company’s equity by taking the stock price and multiplying it by the outstanding
shares. Another way to value an enterprise is by further adding the market value of
debt as the price per bond multiplied by the number of bonds outstanding. The
book value is frequently close to the market price of a bond, and as such, the book
value of debt can be used as a reasonable proxy for its market value. In the
opposite, book value per share of equity is rarely close enough to its market price
to be a reasonably good estimate.

For this method to be used accurately, it is necessary for the stock to be publicly
traded and analyzed by securities analysts, and is not available for privately held
companies. This is further based on the efficient market hypothesis, and that all
necessary materially important information is reflected in the price of the equity.

When negotiating a mergers and acquisitions transaction, the company selling its
equity (and the equity holders) will generally receive what is called a “control
premium.” A control premium is often around 30% to 50% more than the price of
the equity one day before the merger or acquisition announcement. The control
premiums are due to the equity holders of the target company not being willing to
sell unless they benefit more from such a sale, such a control premium is a way of
making it more beneficial to the selling equity holders than not selling the
company. The control premium is further based on the rarity of assets, including
the intangible assets, and the saturation of the company’s assets within the market
and owned by competing businesses, the financial resources of the company
making the bid, or over-inflated market prices.
Replacement Cost Method

This method is based off of the cost of replacing the target company. This method
is not used as often anymore, and as such the discussion on this method will not be
as detailed. The replacement cost method works on a most basic level by the
acquiring company forcing the target company to sell at the price of its equipment
and staffing costs, or else the acquiring company will form a competitor for the
same price and force the target company out of business. This method is least
effective when merging or acquiring a service industry based business.

Discounted-Cash-Flow Method

The principle behind this type of valuation is that a business’s value is based on
that company’s ability to generate and grow its cash flow for the providers of the
capital. In mergers and acquisitions transactions, this method is used to determine
the enterprise value by estimating future cash flows over the horizon period
(explained later), calculating the terminal value at the end of that period, then the
forecasted free cash flows and terminal value are discounted to the present value of
the company’s weighted average cost of capital. Free cash flow is the cash
generated by the business available to be distributed to all providers of capital to
the business. The terminal value is the value at the end of the free cash flow
projection period (also known as the horizon period), and the discount rate is the
rate used to discount the projected future cash flows and terminal value to their
present values.

If done correctly this method is one of the most valuable tools when valuing the
enterprise value of a company, due to this method being: forward-looking and less
dependent on historical results; inward-looking and less influenced by external
factors; based on cash flow and less affected by accounting practices and
assumptions; operating strategies able to be factored into the valuation; and
allowing different components of a business to be valued separately. However,
one must be wary when using this method as the quality of the assumptions made
when calculating the free cash flow, terminal value, and discount rates are integral
in assuring an accurate valuation.

This is only a basic review of each some of the ways to value a business, and is by
no means exhaustive. It is important to remember that your individual
circumstances dictate what is best for you and your company, and it is highly
recommended that you consult with an experienced business law attorney to ensure
your transaction is handled correctly and effectively