What is M&A? When most people hear that a company has acquired a certain brand or entity, all they see is the price of the transaction and the change of ownership. Most people don’t realize the complexity of the transaction, the level of details that goes with it, and the strategy behind the acquisition. In this article, we will go deeper into the meaning of M&A and why companies make M&A a part of their growth strategy.
Mergers and acquisitions (M&A) is a generally used term to describe the process of combining companies through various types of transactions. The most popular one is an acquisition, where one company buys another and transfers ownership. You can do two kinds of acquisitions; a stock sale and an asset sale.
A stock sale is where the buyer purchases the entire business entity and everything that comes with it, including assets and liabilities. Legally, the business still owns the assets and liabilities, but the buyer is the business's new owner. On the other hand, an asset sale is where the buyer purchases a particular asset of the target business, such as a piece of equipment or intellectual property. In some instances, companies even sell an entire business segment which is called a divestiture or a corporate carve-out.
Meanwhile, mergers are where two companies of the same size consensually join together to form one entity. Mergers and acquisitions are often used interchangeably but technically have different meanings. More often than not, mergers tend to end up using one of the company's names or brand, which ends up looking like a takeover or an acquisition as well.
It’s not enough to know what M&A is, but it is also important to understand why companies make M&A a part of their growth strategy. Haven’t you ever wondered why Disney bought 21st Century Fox for $71 Billion?
M&A is a powerful tool that can transform your business overnight. The primary intention is to grow your company fast without doing much of the work. The basic idea is that the buyer will realize more revenue, or cut down costs, by acquiring the target company. This is commonly referred to as synergies.
A synergy means that the combination of two companies should exceed the value that they bring as individual companies. The buyer is looking for a 1+1=3. There are two types of synergies in M&A: cost and revenue Synergies.
Cost synergies are the reduction of costs as a direct result of the combination of two companies. The most common example of this is by achieving economies of scale. If you acquire a company that uses the same raw materials as the ones you are using, you will be able to negotiate a lower price because you will be ordering more from your suppliers.
On the other hand, revenue synergies are the ability to generate more sales as a combined company. For instance, let’s say a clothing manufacturer acquired a shoe manufacturer. The buyer's clients will now buy shoes from them, while the existing clients of the shoe company will also start buying clothes from them.
Strategically, there are three main reasons why companies go through acquisitions; expansion, a defensive play, and a capability acquisition.
The most common reason for an acquisition is to acquire a market share or geographic expansion and product diversification. An excellent example of this is when Apple decided to acquire Beats back in 2014. Before this acquisition, Apple had never sold headphones, but they were working on one at that time. Beats was generating a lot of revenue and had an impressive following. By acquiring Beats, they received product diversification and got Beat's market share for future headphones.
Another reason for acquiring a company is for defensive reasons. To buy the competition means you can solidify the company's position in the market and eliminate future threats. A perfect example of this was when Facebook bought WhatsApp in 2014. WhatsApp was an emerging threat to Facebook that could overthrow them in some markets. Facebook bought WhatsApp to remove the competition, while WhatsApp was able to walk away with a big fat check.
Lastly, capability acquisitions are when a company is acquiring a technology or talent that they don’t have and can’t build, but one that they can leverage better than the target company. Making it from scratch will take time and money while losing market opportunities in the process. At this point, purchasing the capability would be more profitable.
But this is not to say that all acquisitions are success stories. A bad acquisition could also transform your business overnight, just in the wrong direction. Spending a lot of money on an acquisition without getting any return on your investment can be devastating to your business.
An example of this is eBay's acquisition of Skype. The idea was that the integration of both companies would allow communication between buyers and sellers inside eBay, smoothing transaction flow and generating more revenue. eBay didn't foresee that people would not want to talk to strangers about transactions if they can simply email them. eBay soon saw there was no real need for the acquisition and ended up selling two-thirds of Skype just four years later.
In a nutshell, companies do M&A to rapidly increase the growth of their company by gaining an advantage that they wouldn't usually have without the other company. This is probably the only time where 1+1=3. All of these should be considered as a part of a company's M&A strategy before you start any M&A processes.
Mergers and acquisitions are not exclusively about buying and selling. If neither party wants to relinquish ownership, other transactions can be executed to increase the growth rate; such as joint ventures, partnerships, and alliances. There are very thin lines separating these types of agreements. However, from a legal standpoint, they make all the difference in the world.
Joint Ventures are mutual agreements that involve individuals but are more commonly seen among entities and organizations, pooling their resources together, creating a new entity with the sole purpose of accomplishing a specific goal. An example of this was in 2011 when Ford Motors and Toyota Motors agreed to develop new hybrid systems for use in light trucks. At this time, Toyota was the world's leader in hybrid technology while Ford was a market leader for pickups and SUVs. Both parties would learn from this joint venture and integrate the hybrid systems independently on their own.
In this example, both parties had a shared goal. But that may not always be the case. On some occasions, parties will have a different agenda, but both parties will still benefit from the agreement. Depending on the scope of their contract, once they reach the goal, the joint venture will dissolve.
Alliances are much like joint ventures with a few differences. While both parties agree to help each other by sharing their resources, they don't form a separate entity. They don't have a formal agreement at all. Alliances usually form via handshake, and nothing more.
Also, since they don't form a separate entity, they don't work together physically like joint ventures. These parties work together but operate separately and independently from one another. Management and governance of the alliance is usually delegated to an existing employee.
A partnership's intention and structure are very different from joint ventures and strategic alliances. In a partnership, two or more separate individuals agree to form a new legal entity to operate an entire business (inside the partnership). Unlike joint ventures and alliances, the agreement isn't limited to a specific task or goal. Their contract or partnership agreement is geared towards running a long-term business for profits with no time limit.
When do companies go about M&A? To keep it simple, there are two types of acquirers: proactive buyers and reactive buyers.
For large public companies, it is not uncommon to continuously seek growth opportunities. These are the proactive buyers who are consistently looking for opportunities to acquire companies to achieve inorganic growth. These companies are usually sitting in a large pile of cash and use M&A as a large part of their strategy.
The basic principle of an acquisition is when a technology or an idea comes to light, it will probably take months or years to develop and accomplish the full potential of that particular opportunity. Not only are you losing current market opportunities, but there is always a risk of failing to stand up that business. If an existing entity offers the same capability or product that you are aiming for, it is probably best to purchase the entity rather than developing it yourself.
Also, opportunities can arise out of nowhere. These are what we call reactive buyers who stumble upon an opportunity to purchase a company. Sellers can suddenly decide to sell their company for various reasons, which can be a good acquisition for the buyer's company.
Typically, when a private company decides to sell its business, the owner is ready to retire and move away from the company. They could also be serial entrepreneurs who are moving on to their next venture. In any case, this will prompt the buyer to react and consider purchasing the business.
So what is M&A? It’s more than just the buying and selling of a company. There is a lot of strategy and complexity involved in every transaction. Each of the transactions mentioned above are executed to transform a company into a better one. If you want to know what goes on behind the scenes of an M&A transaction, be sure to subscribe to our podcast M&Ascience.com