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What you need to know about mergers and acquisitions

Mergers and acquisitions (M&A) is the term used for the business of merging or acquiring limited companies (also known as private companies) and public limited companies (PLCs). It’s considered a specialism of corporate finance.

What is the difference between a merger and an acquisition?

A merger is when two separate entities combine. The most common structures are either a vertical merger or a horizontal merger. A vertical merger is when two or more companies come together, each with a different supply chain but the same end product or service. This kind of merger often results in synergies leading to reduced costs and increased productivity by gaining greater control of the supply chain.

A horizontal merger usually happens between competitors operating in the same space that want to increase their market share by joining forces and becoming one entity. A joint venture is slightly different – it involves two companies creating a new entity in which they both invest and share profit, loss and control. This business is entirely separate from both parties’ other companies.

Acquisition is when a larger acquiring company selects a target company to acquire through a buyout. Usually these are friendly acquisitions, but there can be what is known as a hostile takeover. This is when the acquirer aims to buy controlling interest directly from a  company’s shareholders without the consent of its directors. It is a completely legal M&A process but because of the ‘unfriendly’ nature of it, it can affect morale and damage company culture.

Consolidation can refer specifically to an amalgamation, which is the acquiring – and sometimes merging – of many smaller companies that then become part of a larger holding group. This is often seen in the creative industries or with startups.

Are mergers and acquisitions good for the economy?

Mergers and acquisitions tend to be good for the economy because they stimulate business growth, create new jobs and offer investment opportunities for all. Cross-border transactions can also help brands and businesses grow in new territories. However, if a company is looking to grow with the intention of merging or acquiring, it needs working capital to do this. A way of increasing capital is to offer shares on the stock market via an Initial Public Offering (IPO).

IPOs and the rise of SPACs

Famous IPOs in recent decades include when Facebook became a public company in 2012 and Alibaba’s record-breaking IPO in 2014. Facebook’s IPO was one of the most anticipated in history, with stock price steadily increasing up to the opening-day of May 18, and some investors suggesting a valuation of $40 per share in the build-up. The year before, LinkedIn’s stock had doubled in value on its first day of trading, from $45 to $90. Yet on the day, numerous factors – including computer glitches on the part of the Nasdaq stock exchange – led to Facebook share prices actually dropping considerably. This continued for the next couple of weeks with stock closing at $27.72 on June 1. Other tech companies took a hit and investment firms faced considerable losses. Nasdaq offered reimbursements, which its rival, the New York Stock Exchange called a “harmful precedent”. Despite these issues, the stock set a new record for trading volume of an IPO at 460 million shares.

Increasingly seen in global M&A, particularly in the US, is a Special Purpose Acquisition Company (SPAC). SPACs are created specifically to raise capital through an IPO and merge with another company. They’re not new, they’ve been around since the 90s, but SPACs have gained popularity with blue-chip private equity firms, investment banks like Goldman Sachs, and leading entrepreneurs. In turn, this kind of backing encourages more private companies to consider going public. 2020 saw the highest global IPO activity in a decade for the USA as well as the largest SPAC IPO in history.

The role of private equity

Private equity is capital which is not listed on a public stock exchange. Private equity firms are major players when it comes to M&A deals because they are powerful enough to keep on investing capital over an extended period of time. They have a pool of money accrued from previous M&A transactions, which then feeds into further deals. They also receive private equity from limited partners, pension funds, and capital from other companies. The firm, or fund as it is sometimes known, has good cash flow because of this.

Real estate is a form of private equity. There are private equity firms that specialise solely in the purchase of real estate, and by building a property portfolio they create further investment capital. Property is then improved and rented out, or sold on at a higher price, keeping the fund topped-up. Private investors see a return on their investment, and the money that’s left becomes working capital for the fund’s next venture.

Due diligence and pre-M&A analysis

One of the key steps in any merger or acquisition is the due diligence process. This is when investigations and audits are carried out to verify that all financial information provided by the target company is correct and that the purchase price is justified. Discounted Cash Flow (DCF) analysis is part of due diligence. It’s a method used to estimate the value of investment based on its predicted future cash flows.

Another important tool is Accretion Dilution Analysis. This is a basic test carried out before an offer is even made to determine whether a merger or acquisition will increase (accretion) or decrease (dilution) the Earnings per Share (EPS) once completed.

Intellectual Property (IP) must be taken into account as well. Acquisitions with an interest in gaining IP assets can have transaction values of billions. A thorough understanding of the complexities of such high-stake transactions is needed in order to derive precise valuation numbers when negotiating a deal.

Why work in mergers and acquisitions?

Global M&A is seeing growth in all sectors, even as the pandemic has seen some major companies fold. The way that we do business continues to be reshaped by world events, and the flux means that there are many business opportunities to take advantage of through mergers and acquisitions. Global M&A in financial services is seeing a boom with the start of 2021 being the busiest since 1980. The predominance of SPACs is set to spread outside of North America, and brings with it a demand for experienced managers and management teams.

Diversification acquisition will see larger companies offering size and scale to smaller companies which perhaps do not have the capital or resources to adapt in their offering, but which are otherwise doing well. At the other end of the spectrum, specialism may be needed, for example in healthcare, which is seeing a spike in demand for home healthcare solutions. Either way, business continues to seek a competitive advantage and mergers and acquisitions continue to provide this.

If you’re interested in learning more about the world of mergers and acquisitions, there are numerous finance-focused podcasts which look specifically at global M&A activity.

Learn more about mergers and acquisitions 

Mergers and acquisitions are a cornerstone of international businesses. Find out how you can sharpen your expertise in international business and mergers and acquisitions with the University of York’s MSc International Business Leadership and Management.