Private Company Mergers &

Acquisitions
In order to adapt to competitive pressures, advancements in technology, and economic
conditions, privately-held companies are often forced to adapt their business by
acquiring or partnering/merging with another company in order to remain competitive or
simply to grow their business. A private company may also sell itself to a larger public
company for the same reasons. Private companies may reconfigure their assets,
operations, and relationships with the stockholders in search of higher growth, new
technology, business expansion, and greater revenues.
Mergers, acquisitions, and corporate restructurings often enable a private company to
develop a competitive advantage by increasing flexibility, growth, and shareholder
value. Common M&A motives include: strategic growth, talent growth (“acq-hire”),
preparation for an IPO or exit, and entering a new geographic or demographic market
(buy vs. build).

Types of Private Company M&A and

Similar Transformative Transactions
Expansion Transactions
Expansion is an increase in the size of a private company’s business due to a
transformative transaction. There are a variety of reasons private companies choose to
expand through an expansion transaction rather than naturally (“organically”). First of
all, growth happens much faster, virtually overnight in some cases, whereas natural
organic growth takes time as its sales grow. A private-held company may want to
eliminate a competitor, enter a new geographic market, introduce a new product line, or
bring on the talent and management team that results from an expansion transaction.
Expansion can be accomplished through mergers, asset acquisitions, tender offers or
joint ventures. The following methods can be used to help a private company grow
without having to create a whole other business entity.

 Merger—A private company merger is when two or more private companies

combine to form a single entity under a consolidated management and
ownership. A merger can take place through an amalgamation or absorption.

o Amalgamation—An amalgamation is when two or more private companies

enter into the merger agreement to form a completely new entity. In this
 type of merger both private companies lose their identity and a new
private company is formed to manage the consolidated assets.
Amalgamation tends to occur when both private companies are of equal
size.

o Absorption—Absorption is when the merger occurs between a two entities

of dissimilar size. In such a case, the larger private company would absorb
the smaller one. The fusion dissolves the smaller private company and
places all its assets in control of the larger private company. Absorption
may also take a smaller private company and make it a stand alone
operating division or subsidiary of a larger private company.

 Acquisition—A private-market acquisition is when a company (public or private)

buys up the stock of a private company. An acquisition may also take the form of
an “asset acquisition”, where rather than buying the stock, the buyer simply buys
the entirety or a portion of the assets of another private company. The assets
may be tangible such as plants and machinery, or intangible assets such as
patents and trademarks. The target private company may then continue as a
smaller company or dissolve.

 “Acq-hire”—An “acq-hire” (or acquisition-by-hire) may occur especially when the

target private company is quite small or is in the startup phase. In this case, the
acquiring company simply hires the staff of the target private company, thereby
acquiring its talent (if that is its main asset and appeal). The target private
company simply dissolves and little legal issues are involved.

 Tender Offer—A tender offer is an offer by an acquiring company to the general

shareholders of a target private company to purchase a majority of the equity at a
premium to market value. Tender offers are an attempt to gain management
control through holding the majority of voting equity. Note that tender offers are
less common for private companies than they are for publicly traded companies.
  Joint Venture—A joint venture is when two or more private companies enter into
an agreement to allot a portion of resources towards the achievement of a
particular goal over a designated period of time. Synergies occur when
businesses capitalize on joint opportunities or other combined efforts to obtain an
effect greater than working alone, whether it is increased revenue or decreased
costs.

Key Differences Between Mergers and

Acquisitions
Although often very similar, mergers and acquisitions are two distinctly separate types
of transactions. In the purest sense, a “merger” refers to a merger of equals: two
companies of the same size come together, surrender their shares, and issue new
shares for a new, combined company. In a merger, the merging organizations surrender
their shares and issue new shares for a new, combined company.
A merger of equals is actually quite rare since most deals that are reported as a merger
are actually acquisitions, where one firm actually purchases and assumes ownership of
the other. Acquisitions are often publicized as mergers because they’re easier for the
target firm and PR teams to swallow and are believed to help promote a more
successful integration of the firms’ operations. In some acquisitions, the acquirer will
create a Merger Sub for the transaction. A Merger Sub is a non-operating legal entity
that acts as an investment vehicle for the acquirer, allowing it to merge the target with
the Merger Sub entity, labeling the acquisition as a merger.
Many small private firm targets are actually acquired as an asset purchase rather than a
formal acquisition. An asset purchase transaction may take place in lieu of an
acquisition if the target firm’s accounting practices are not in compliance with Sarbanes-
Oxley or if the acquiring firm couldn’t afford to spend the time or resources required for
a full due diligence process. After the asset purchase transaction is complete, the target
company will often still exist, although without active operations, in order to pay off its
remaining bills before dissolution and the distribution of remaining funds to
shareholders.

Types of Mergers
 Horizontal Merger—A horizontal merger is when two private companies from
the same business class or market enter into a merger agreement. In a
 horizontal merger, the merged private companies benefit from economies of
scale and increase total market share by consolidating facilities, combining
operations, increasing working capital, reducing competition, or reducing
advertisement costs, etc.

 Vertical Merger—A vertical merger occurs when two firms from different stages
of the same business class, activity or operation enter into a merger agreement.
These types of private companies typically have buyer-seller or supply chain
relationships before the merger. Generally, private companies attempt vertical
mergers or hostile takeovers of other firms to maximize backward or forward
integration along their supply chain. The acquiring private company reaps the
benefits of a reduced inventory and more efficient allocation working capital.

 Conglomerate Merger—A conglomerate merger is when two private companies

that operate in different or unrelated business lines enter into the merger
agreement. Firms choose to enter into a conglomerate merger to benefit from the
access to greater financial resources. Firms, by expanding into new markets and
different businesses, create a diverse portfolio of products that balance business
risk.

Key Differences Between Public and

Private M&A
Both Public and private companies engage in M&A transactions, but there are several
key differences to note between the processes for each. These characteristic
differences are expanded upon below:
Public Company M&A Private Company M&A
Due to the high liquidity of publicly traded stock, public firms may more easily use their
shares as M&A currency.
Can raise money from the public market to help finance an M&A transaction.
Not subject to an illiquidity discount.
Public M&A transactions must be approved by the SEC for anti-trust purposes and also
require Sarbanes-Oxley compliance.
Private Company M&A
Although in some cases, a private company may use its stock as currency for an M&A
transaction, an illiquidity discount applies. A valuation method that consists primarily of
discounted cash flow and asset valuation is most likely to apply and the private firm will
most often use cash to acquire a given target.
Cannot raise money from the public market and must resort to debt financing, venture
capital, or other private forms of funding.
Private firms suffer an illiquidity discount that may revolve around 20-30%.
Sarbanes-Oxley compliance is only relevant to private companies that have future plans
to go public or to be acquired by a public firm.

Strategic Vs. Financial Buyers

Potential private company buyers and investors fall into two
primary categories:
1. Financial Buyers—Financial buyers include private equity firms (also known as
financial sponsors), venture capital firms, hedge funds, family investment offices
and ultra high net worth individuals. These firms and executives are in the
business of making investments in private companies and realizing a return on
their investments. Financial buyers look to identify private companies with
attractive future growth opportunities and durable competitive advantages, invest
capital in their operations, and realize a return on their investment upon exit via a
direct sale or an IPO.
2. Strategic Buyers—Strategic buyers search for operating private companies that
offer products or services similar to their own. Targets of strategic buyers are
often competitors, suppliers or customers of the original firm. Strategic buyers
can also aim to acquire firms that have operations that are unrelated to their core
businesses. Such an acquisition would be considered as an attempt of a
strategic buyer to diversify their revenue sources. Their goal is to identify private
companies whose products or services can synergistically integrate with their
existing businesses to create long-term shareholder value.

Contraction Transactions
Contraction is the reduction in the size of the private company
or business due to corporate restructuring. For more information
on contractual corporate restructuring, please see PrivCo’s
Knowledge Bank chapter on Bankruptcy and Restructuring.

 Spin-Offs—A spin-off transaction is when a parent private company separates

the shares of its subsidiary from the original private company shares and
distributes those shares, on a pro-rata basis to its shareholders. In essence, two
separate entities are formed in which the stockholders are issued the shares in
the legal subsidiary proportional to their original holdings in the parent private
company. Both the entities have their own management and run individually after
the spin-off. The distribution of the subsidiary’s stock to shareholders is in the
form of a dividend. This is typically a tax-free transaction for both the
shareholders and the parent.

 Split-Offs—A split off is the separation of a subsidiary from the parent by

splitting the shareholders of the parent private company’s stock from the
shareholders of the subsidiary’s stock. Most split-offs are tax-free transactions
and used to downsize a private company or defend against a hostile takeover. In
a split-off a new private company is created to take over the operations of an
existing unit or division and some of the parent private company’s shareholders
will receive the stocks in subsidiary or in new private company in exchange for
the parent private company’s stocks. As a result, the parent private company will
be able downsize its overall business.

 Split-Ups—A split up is when an entire firm is broken up in the series of spin-

offs. After a split-up the parent private company no longer exists, only the spun-
off businesses of the original private company survive. In a split-up transaction,
new classes of stock are created to track the operations of each of the individual
subsidiaries. The new classes of shares are distributed as a dividend to current
stockholders and then the parent private company is dissolved.

 Divestiture—A divestiture is a direct sale of a portion of the parent private

company to an outside party in return for cash. Generally a firm sells struggling
 operations that operate at a loss or require upkeep capital. A parent private
company may also divest non-strategic or non-gaining businesses and invest the
proceeds of the sale in potentially higher return opportunities or core business
expansion. Divestitures may also be used to realize the true potential of an
outperforming asset, whose performance is not properly valued by the market.
The tax basis of the asset intended for divestiture will be considered before
deciding on the appropriate type of divestiture.

 Equity Carve-Out—An Equity carve-out is a sale of a portion of equity in a

subsidiary to the public via an IPO. The parent private company retains the
majority stake in the subsidiary, usually greater than 80%. With ownership of
over 80%, the parent private company still retains the right to undertake spin-offs
and split-offs on a tax free basis. In an equity carve-out, a new legal entity is
created and issues new shares, which are distributed to outside investors.

 Asset Sale—An asset sale involves the sale of tangible or intangible assets of
the private company to generate cash. This cash can be used to pay out a
dividend, adjust capital structure, or purchase other assets or investments. In an
extreme case, an asset sale may be part of a Chapter 7 liquidation plan where a
private company ceases all business operations and sells all its assets. (See
PrivCo’s Knowledge Bank chapter on Bankruptcy and Restructuring for more
information on Chapter 7 liquidations.)

Ownership Change Transactions

An ownership change transaction is exactly what it sounds like:
a transaction where the company’s ownership changes so the
firm welcomes new owners or a different composition of
ownership stakes for its existing shareholders.
  Minority Share Sale & Venture Capital—A private company can have a change
in its ownership structure if it sells some of its shares to an outside investor, such
as an individual (“Angel”) or venture capital firm (“VC Firm”). Note that in the case
of venture capital deals, this often occurs in conjunction with a Change of Control
since the VC Firm will usually demand Board seats, preferred stock and dividend
rights in addition to other rights and terms.

 Initial Public Offering (IPO)—By going public via an Initial Public Offering (IPO),
the company can change control of the company from the private owners’,
founders’, or controlling family’s hands to partially (even a majority) public
investors. An IPO often has the added benefit of providing both expansion capital
as well as liquidity for the company.

 Leveraged Buyout (LBO)—A leveraged buyout is a

situation in which a group of investors (usually a private
equity firm) acquire a controlling interest in a given private
company’s equity by borrowing a large portion of the
capital necessary to finance the transaction. The acquired
private company’s assets are often used as collateral
against the borrowed capital. In a leveraged buyout
situation, a combination of debt instruments from bank and
capital markets are deployed.

Leveraged buyouts use a highly leveraged capital structure

where the majority of the cash flow from the acquired private
company, division or subsidiary is used to service and repay the
loan. Leveraged buyouts may be used to enhance shareholder
value, counter takeover threats or realize the value of
undervalued assets.

 Employee Stock Ownership Plan (ESOP)—An employee stock option plan is a

transaction where a private company makes a tax deductible contribution of cash
or company stock into a trust. The trust’s assets are then allocated to employees
through the use of stock options and are not taxed until the employees exercise
their option. Since the creation of an ESOP concentrates a private company’s
ownership, they can be used as an anti-takeover defense mechanism.

 Leveraged ESOP—Although uncommon, leveraged ESOPs are typically used to

concentrate the ownership of a private company into the employees’ hands, often
to defend against a possible takeover. An ESOP is an employee stock ownership
plan where employees own a piece of equity in the private company. Leveraged
ESOPs are initiated by borrowing capital to capture a majority of the equity at
one time. This equity can then be vested over a period of time to the employees.
Leveraged ESOPs drastically alter both the capital structure of a private
company (by increasing the liabilities), and the ownership concentration from the
original owners/management to the employees.

 Share Repurchase—A share repurchase program is a measure implemented by

cash-rich corporations to concentrate the ownership of the private company by
purchasing equity shares at a premium to market value. Private companies can
use share repurchase programs to accrete the ownership of upper level
management, lever up the balance sheet and thwart the threat of a takeover.
Share repurchases lead to decreased equity capital of the private company.
While less rare for private companies than for publicly traded ones, many private
companies that have the cash to do so can make a tender offer in order to
reduce the number of shareholders and concentrate ownership and control of the
company.
  Takeover—In recent years there has been a high level of hostile takeovers.
Takeovers can be defined as acquiring control of the private company or
management by stock purchase or stock exchange. The majority of takeovers
have come in the form of leveraged buyouts, proxy battles, or forced internal
restructuring by vocal institutional investors who aim to maximize the shareholder
value of their clients. Hostile takeovers are relatively rare for private companies,
but can and do occur.

Change of Corporate Control Without

a Transaction
Changes in control of a private company often occur as a result
of a Change of Ownership Transaction (see above) such as an
M&A deal or a Venture Capital or Private Equity investment.
However, change in control of a private company can also
occur without an acquisition or divestiture. Corporate control is
the control over the management of the firm. Management
decisions influence strategy of the organization and directly
impact employee tasks.

During an internal restructuring or change of control, a private

company evaluates its internal process, and management team.
A change of control can result from:

 Board Seat Changes—Since ultimately the company’s Board of Directors

controls the company, voluntary changes made to the private company’s Board
of Directors will result in a change of control without a merger, acquisition, or
other transformative transaction. Changes in the private company’s Board of
 Directors may be made for a variety of reasons: the company may need
additional expertise in a certain area for example. A Director may also be forcibly
removed by the private company due to the Director’s conflict of interest, or the
private company’s accountants may force the addition or removal of a Director
because the accounting firm feels the Board lacks independence from
management, needs an Audit Committee or a Compensation Committee to make
independent decisions regarding the firm’s books and records (Audit Committee)
or management’s pay and compensation (Compensation Committee).

 Management Changes—Via its Board, a firm may hire a new CEO, CFO or
make other changes in its Executive Team, resulting in a change of control
without any M&A transaction (Note that PrivCo has a Leadership Change” tag
that enables users to search by this tag in order to target M&A or investment
opportunities).

 Generational Changes—Change of control of the private company may also

take place without an M&A transaction due to the death of the private company’s
Founder and passage of the company to the next generation (Note that PrivCo
has a “Generational Change” tag on a private company when this occurs to allow
our users to search by this tag in order to target M&A opportunities or investment
opportunities).

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