Why Do Mergers & Acquisitions Take Place?

Although Mergers and Acquisitions are often used as synonymous terms, there is a difference between the two concepts.

With a merger, two firms together form a new company. After the merger, the separately owned companies become jointly owned and obtain a new single identity and the stocks of both firms are surrendered and new stocks in the name of the new company are issued.

With an acquisition, one firm takes over another and establishes its power as the single owner. Generally, the firm which takes over is the bigger and stronger one. The relatively less powerful, smaller firm loses its existence, and the firm taking over, runs the whole business with its own identity. The Takeover can be friendly or hostile.

M&A activity has been a feature of corporate finance work for many years. So why do acquisitions take place? What are some of the common factors for business owner’s particular motivation for making a specific acquisition or disposal? When we look at the factors, we should not assume that they only fall into one of these categories: very often they fall into more than one at the same time or none at all. Let us look at some of these factors:

(i) Diversification and conglomeration

This was particularly fashionable as an aspect of corporate strategy in the 1960 and 1970s. For example, a tobacco company might own an insurance company and a paper packaging business. The thinking was that if one sector was depressed, another was just as likely to be booming, so as jack of all trades a diversified company could ensure an overall picture of steady performance and reduce the shareholder’s investment risk. The Virgin group founded by Richard Branson with 200 businesses and 25,000 employees all around the world is an excellent example of a diversified success. The corporate rationale being to diversify into as many markets feasible in order to extend the Virgin brand.

(ii) Consolidation

This is the reverse of diversification. This is based on the concept that a company does better when it concentrates on what it really knows. Companies feel safer when they only have to worry about what they identify to be their core business.

(iii) Vertical integration

It is the process of integrating into the company both suppliers and buyers of its goods and services as a way of producing those goods and services more cheaply. It therefore reduces the transaction cost. Example of a vertical integration takes place when a paper manufacturer decides to buy a forestry business and a chain of stationary shops which sell the paper product it makes. The Pixar- Disney merger is a good example of a vertical integration. The merger brings together Disney's historic franchise of animated characters, such as Mickey, Minnie Mouse and Donald Duck, with Pixar's stable of cartoon hits, including the two "Toy Story" films, "Finding Nemo" and "The Incredibles."

(iv) Horizontal integration

This is the process of buying a similar business to your own at the equivalent point in the production cycle. Example of a horizontal integration will take place when a paper manufacturer buys a packaging business or another paper manufacturer. The objective is to achieve economies of scale or to create a single organization of sufficient size to compete with the rest of the opposition.

(v) Non-commercial reasons

A buyer may have a number of reasons for wishing to expand. A seller's motives are likely to be financial or commercial ones. In a small family business, reasons wanting to sell could be based on non-commercial reasons such as poor health, lack of management succession or even simply a wish to do something different.

About the Author

Elahe Ghazinoori

Elahe Ghazinoori founded EMG Associates, a legal consultancy firm, in 2006 having formerly practiced as an in-house solicitor for a telecommunications company. As EMG Associates' principal presenter, she has a wealth of experience in providing inspiring and engaging training sessions.

Elahe has trained hundreds of lawyers and legal professionals around the world on subjects such as company law, commercial law, contract law, drafting skills, partnership law, insolvency and bankruptcy law, corporate finance, intellectual property and dispute resolution.

Elahe lectures for BPP Law School in their Legal Practice department on subjects such as business law and private company acquisitions. She also worked as a senior training consultant for over 5 years for one of the world’s largest corporations, American Airlines.