Mergers & Acquisitions (M&A) -

https://corporatefinanceinstitute.com/resources/valuation/mergers-acquisitions-ma/

Transactions of two companies combining in some form

What are Mergers & Acquisitions (M&A)?

Mergers and acquisitions (M&A) refer to transactions between two companies combining in some
form. Although mergers and acquisitions (M&A) are used interchangeably, they come with different
legal meanings. In a merger, two companies of similar size combine to form a new single entity.

On the other hand, an acquisition is when a larger company acquires a smaller company, thereby
absorbing the business of the smaller company. M&A deals can be friendly or hostile, depending on
the approval of the target company’s board.

Summary

Mergers and acquisitions (M&A) refer to transactions involving two companies that combine in some
form.

M&A transactions can be divided by type (horizontal, vertical, conglomerate) or by form (statutory,
subsidiary, consolidation).

Valuation is a significant part of M&A and is a major point of discussion between the acquirer and
the target.

Mergers and Acquisitions (M&A) Transactions – Types

1. Horizontal

A horizontal merger happens between two companies that operate in similar industries that may or
may not be direct competitors.

2. Vertical

A vertical merger takes place between a company and its supplier or a customer along its supply
chain. The company aims to move up or down along its supply chain, thus consolidating its position
in the industry.

3. Conglomerate

This type of transaction is usually done for diversification reasons and is between companies in
unrelated industries.

Mergers and Acquisitions (M&A) – Forms of Integration

1. Statutory

Statutory mergers usually occur when the acquirer is much larger than the target and acquires the
target’s assets and liabilities. After the deal, the target company ceases to exist as a separate entity.

2. Subsidiary

In a subsidiary merger, the target becomes a subsidiary of the acquirer but continues to maintain its
business.

3. Consolidation
In a consolidation, both companies in the transaction cease to exist after the deal, and a completely
new entity is formed.

Reasons for Mergers and Acquisitions (M&A) Activity

Mergers and acquisitions (M&A) can take place for various reasons, such as:

1. Unlocking synergies

The common rationale for mergers and acquisitions (M&A) is to create synergies in which the
combined company is worth more than the two companies individually. Synergies can be due to cost
reduction or higher revenues.

Cost synergies are created due to economies of scale, while revenue synergies are typically created
by cross-selling, increasing market share, or higher prices. Of the two, cost synergies can be easily
quantified and calculated.

2. Higher growth

Inorganic growth through mergers and acquisitions (M&A) is usually a faster way for a company to
achieve higher revenues as compared to growing organically. A company can gain by acquiring or
merging with a company with the latest capabilities without having to take the risk of developing the
same internally.

3. Stronger market power

In a horizontal merger, the resulting entity will attain a higher market share and will gain the power
to influence prices. Vertical mergers also lead to higher market power, as the company will be more
in control of its supply chain, thus avoiding external shocks in supply.

4. Diversification

Companies that operate in cyclical industries feel the need to diversify their cash flows to avoid
significant losses during a slowdown in their industry. Acquiring a target in a non-cyclical industry
enables a company to diversify and reduce its market risk.

5. Tax benefits

Tax benefits are looked into where one company realizes significant taxable income while another
incurs tax loss carryforwards. Acquiring the company with the tax losses enables the acquirer to use
the tax losses to lower its tax liability. However, mergers are not usually done just to avoid taxes.

Forms of Acquisition

There are two basic forms of mergers and acquisitions (M&A):

1. Stock purchase

In a stock purchase, the acquirer pays the target firm’s shareholders cash and/or shares in exchange
for shares of the target company. Here, the target’s shareholders receive compensation and not the
target. There are certain aspects to be considered in a stock purchase:

The acquirer absorbs all the assets and liabilities of the target – even those that are not on the
balance sheet.
To receive the compensation from the acquirer, the target’s shareholders must approve the
transaction through a majority vote, which can be a long process.

Shareholders bear the tax liability as they receive the compensation directly.

2. Asset purchase

In an asset purchase, the acquirer purchases the target’s assets and pays the target directly. There
are certain aspects to be considered in an asset purchase, such as:

Since the acquirer purchases only the assets, it will avoid assuming any of the target’s liabilities.

As the payment is made directly to the target, generally, no shareholder approval is required unless
the assets are significant (e.g., greater than 50% of the company).

The compensation received is taxed at the corporate level as capital gains by the target.

3. Method of payment

There are two methods of payment – stock and cash. However, in many instances, M&A transactions
use a combination of the two, which is called a mixed offering.

4. Stock

In a stock offering, the acquirer issues new shares that are paid to the target’s shareholders. The
number of shares received is based on an exchange ratio, which is finalized in advance due to stock
price fluctuations.

5. Cash

In a cash offer, the acquirer simply pays cash in return for the target’s shares.

Mergers and Acquisitions (M&A) – Valuation

In an M&A transaction, the valuation process is conducted by the acquirer, as well as the target. The
acquirer will want to purchase the target at the lowest price, while the target will want the highest
price.

Thus, valuation is an important part of mergers and acquisitions (M&A), as it guides the buyer and
seller to reach the final transaction price. Below are three major valuation methods that are used to
value the target:

Discounted cash flow (DCF) method: The target’s value is calculated based on its future cash flows.

Comparable company analysis: Relative valuation metrics for public companies are used to
determine the value of the target.

Comparable transaction analysis: Valuation metrics for past comparable transactions in the industry
are used to determine the value of the target.

Related Readings

Thank you for reading CFI’s guide to Mergers & Acquisitions (M&A). To keep advancing your career,
the additional CFI resources below will be useful:

M&A Deal Structure

Cash Offer
Hostile Takeover

Comparable Company Analysis

See all valuation resources

See all equities resources

Share this article

Get Certified for Financial Modeling (FMVA)®

Gain in-demand industry knowledge and hands-on practice that will help you stand out from the
competition and become a world-class financial analyst.

Learn More

CFI logo

We're hiring!

Company

About

Meet Our Team

Careers at CFI

Editorial Standards

Learner Reviews

University Partnerships

Industry Partnerships

Affiliates

Certifications

Financial Modeling & Valuation Analyst (FMVA®)

Commercial Banking & Credit Analyst (CBCA®)

Capital Markets & Securities Analyst (CMSA®)

Financial Planning & Wealth Management (FPWM™)

FinTech Industry Professional (FTIP™)

CPE Credits

Courses

Excel

Financial Modeling

Accounting

Financial Planning & Analysis

Environment, Social, Governance (ESG)

Valuation

Capital Markets

All Courses

Support

Help | FAQ

What’s New

Contact Us

Financial Aid

Legal

Resources

eLearning

Career

Team Development

Excel

Management

Data Science

All Free Resources

Logo

Logo

Logo

© 2015 to 2024 CFI Education Inc.

Follow us on LinkedIn Follow us on Instagram Follow us on Facebook Follow us on YouTube

Privacy Policy

Terms of Use
Terms of Service

Legal

Top of Form

Bottom of Form