What Are Mergers and Acquisitions (M&As)?

Mergers and acquisitions make news headlines all the time. While many think they know what these deals are, there are several kinds of business transactions that fall under the label of 'mergers and acquisitions'.

Catch up on the different types of mergers and acquisitions, discover why they happen, and learn about the various components to these deals. Last, find out the best way to stay organized when preparing for a merger or acquisition.

Types of Mergers & Acquisitions

Mergers and acquisitions, often shortened to M&A, is an umbrella term that is applied to many types of corporate consolidations. These terms are sometimes used independently and interchangeably. However, mergers are different from acquisitions.

For clarity's sake, it is important to know the different types of M&A transactions and how they differ from one another. Here are the most common types of M&A deals:

• Merger: In a merger, two companies decide to come together. Once shareholders approve of the deal, the companies combine as a new entity, which may keep the name of one of the parties. One example is Citigroup, the entity created by the merger of Travelers Insurance Group and the financial entity Citicorp.
• Acquisition: In an acquisition, one company acquires a second company. The two parties keep their business names and structures, which can be useful if both have strong brand followings. A well-known example of an acquisition is when Omrix Biopharmaceuticals was acquired by pharmaceutical giant Johnson & Johnson.
• Tender Offer: In a tender offer, a business offers to purchase another firm's stock at a special price, typically below the market rate. The company that receives the offer can ask for shareholder approval, bypassing the board of directors.
• Acquisition of Assets: Here, one company purchases the assets of another. This is often a side effect of liquidation or bankruptcy dealings when a company must sell its assets to settle debts.
• Management Acquisitions: Also known as a management-led buyout, this structure refers to the purchase of a controlling stake in a public company by its executives, who then take the company private. These transactions must be approved by shareholders. An example is when Dell's founder bought out the computing company, which had previously been a publicly traded company.

Types of M&A Deal Structures

Mergers and acquisitions can be completed using several structures. These are terms used to categorize the structure of a deal:

• Horizontal: This describes a merger between direct competitors that share the same niche or consumer market.
• Vertical: A vertical M&A describes a hierarchical relationship, such as between a company and its supplier or a company and its customer.
• Congeneric: A congeneric deal is one between two companies that serve the same market in different ways, such as athletic wear and sneakers.
• Conglomeration: This describes a merger between companies when there is no business overlap.

Why Do M&As Happen?

You might be wondering why companies would agree to a merger or acquisition if they are thriving on their own.

The two main drivers for M&As are growth and competition. Businesses want to grow, so they tend to think “M&A” when they believe it will help them do so. With competition, businesses may decide to join forces to unite against an industry-leading foe. Alternately, a major player may scoop up a smaller player if market conditions are right.

Keeping these motivations in mind should help you understand why mergers and acquisitions take place, but let's review more examples:

• Seeking opportunity for stronger growth: By purchasing another company, a business can instantly boost revenue and broaden its audience without having to grow organically (which tends to take a long time). Likewise, a business can purchase another company that offers a service or product it does not have. The M&A process is a shortcut to in-house development because the acquiring company can offer that service or product without having to build it themselves.
• Seeking synergistic/complementary company: M&As sometimes happen when two companies realize that they can form a single company that is worth more than the individual businesses. Other times, companies realize they can reduce expenses by joining forces due to economies of scale.
• Diversifying business endeavors/involved markets: Markets move in a cyclical manner where industries experience hot and cool cycles. A business might want to take on a company in a different industry to avoid these ebbs and flows.
• Increasing market power/financial authority: Larger companies tend to have more power and influence, such as to negotiate a favorable price with a supplier. By combining, smaller companies can increase their market power and financial authority.
• Tax benefits: There are some tax benefits to M&As. A business may decide the time is right to look for a deal if they want to gain taxable income or carry a tax loss forward, reducing tax liability. Note, however, that this is more of a perk than the main driver for an M&A — it would be surprising for a company to undertake an M&A just to skip out on taxes!

Determining Company Valuation During an M&A

During the M&A process, both parties will have to agree on a price for the business that is being purchased. The company valuation process is complex and depends on variables such as tangible and intangible assets; recently completed deals; business history and reputation; and other factors. Typically, a business appraiser is called to review the documentation and come up with an independent valuation for the company, so the deal can proceed.

There are three common M&A valuation methods an appraiser can use for the company valuation: discounted cash flow, market, and cash value.

Once the appraiser chooses the method appropriate for the deal, she or he will then review the various factors to come up with the valuation. For example, she or he might determine the value of all assets held by the business, then subtract debts and liabilities to arrive at a valuation. Alternatively, the appraiser might look to precedent, which is the price of recently completed M&A deals in the same niche.

Components of an M&A Agreement

Most M&A agreements include these clauses:

• Representations and warranties: This is a summary of facts related to the deal as of the closing data — sort of like a legal assessment of what is known to be true. Information found in this section includes attestations of business taxes paid; known issues with employees; or notification of any pending legislation. This is intended to establish good faith on both sides.
• Covenants: Covenants set conditions by which the parties must adhere for a short time before and after the closing. For example, a seller might have to agree to continue business operations as normal and hold onto any business assets leading up to the merger. They would be prevented from selling any business assets and pocketing the cash before the M&A closes.
• Conditions: Conditions are terms that must be met before the deal can close. If these conditions are not met, either side can cancel the deal.
• Deal protections: This clause specifies certain terms that must be met for the deal to go through. For example, there may be a "breakup fee" where one party must pay the other party to get out of the deal.
• Schedules: Here, schedules reflect an updated list of what the buyer is selling to the acquiring company. For example, the business might list all outstanding contracts or all outstanding debts and creditors.

Forms of Acquisition and Payment Methods

Finally, both sides will need to determine the financial structure of the deal. A company might put up cash to purchase another business. If the business being acquired is in debt, the company taking over might pay off that debt as a form of acquisition. A company could also use stock shares to purchase the business. Often, companies will use a combination of these methods for an M&A transaction.

Underpinning these deals is M&A due diligence, where both parties reveal business information, including finances and proprietary information. The due diligence begins once an M&A letter of intent is signed, and it continues until the sides negotiate a deal.

These days, most M&A deals rely on a virtual data room to upload and organize documents for the due diligence phase of the transaction. If you are seeking a virtual data room vendor, discover how DFIN's purpose-built software can help protect security, organize information seamlessly, and help complex deals move forward.