In corporate finance, mergers and acquisitions are financial transactions in which the total ownership of different business enterprises, individual firms, or their joint operating units are merged or acquired. The merger is often seen as a straight transaction between two entities where the entities share equal shares of the invested funds. However, there are a few reasons why merging and acquisition is referred to as a combination rather than a pure merger. For instance, in a typical acquisition, when an individual firm completes a merger and acquisition transaction with an entity that belongs to a different sector of business, the acquired firm will be able to manipulate or influence decisions made by the acquiring firm.
Combinations are commonly seen in mergers and acquisitions due to the significant potential tax benefits that exist. A successful merger and acquisition require that all of the assets and liabilities of the merging entity be combined into one ownership. Therefore, the combined entity is treated as a single legal entity with all of its own liabilities, assets, and obligations. In most cases, a corporation will have significantly less debt than the combined entities. Due to the amount of tax benefit provided through mergers and acquisitions, this is often viewed as a favorable type of transaction that requires only a low amount of initial start-up capital.
Many corporations view a merger and acquisition as a way of acquiring a firm that has already shown financial inferiority over a period of time, when the value of the combined entity is based on future earnings. Because of the potential tax benefit associated with a merger and acquisition transaction, a major hurdle for many companies wishing to acquire other companies is the financial performance of these potential acquirers. The ultimate objective of a purchase of a company is to buy a business that has the ability to generate a profit while still having a marketable enterprise to operate. To achieve this goal, the financial performance of the acquired firm must be examined closely.
Merger and acquisitions may be conducted through two methods, direct and indirect. Direct mergers are when one company creates a direct association with another in an attempt to create a larger business through a merger or acquisition. Indirect mergers occur when a direct entity and an indirect entity make a combination through a stock purchase or equity financing. However, even though this occurs less frequently, there are instances where indirect cross border mergers can be considered for a successful acquisition.
There are two types of mergers and acquisitions that are generally identified by their cost. These costs are fixed and variable and should be appropriately assessed during the merger analysis process. Fixed rate mergers typically have a lower impact on the acquirer’s cash flow because the acquirer is not changing the underlying business model. Because variable rate mergers are not tied to any specific economic model, they are more susceptible to significant rate changes in the economic environment changes.
Another important factor that should be considered in mergers and acquisitions is the target market or customer profile. For example, a grocery store chain can merge with a hardware store in order to provide customers with a more comprehensive selection of hardware products. Likewise, a health care company can acquire another company that focuses on medical equipment or laboratory supplies in order to meet the needs of patients. Regardless of the type of business in question, the rates that are charged between merging companies will vary based on a number of factors including the location of the companies, customer characteristics, the amount of capital required, the industries that are most complementary to each other, and the geographic structure of the acquiring company.
Integration has a significant impact on the success of mergers and acquisitions. A good example of integration is when the acquiring company acquires a manufacturing company that produces equipment used in production of that company’s products. The purchasing company then refines the equipment and makes it available for sale to its existing customer base. This allows the acquiring company to realize synergies that lead to enhanced productivity, cost savings, competitive advantage, and expanded market share. Any financial performance measures taken at the time of the acquisition should include an analysis of the cost savings realized as a result of the merger and any effects that improved efficiency might have for the overall financial performance of the enterprise.
Cross border mergers are when two or more corporations make deals to acquire companies in different regions and countries. An example would be a pharmaceutical firm that acquires a generic drug manufacturer in India in order to manufacture a new, lower cost product. The resulting company would have significantly fewer barriers to entry than a pure play pharmaceutical firm that simply wants to produce its own product and do not care about selling a product that does not meet the company’s needs. As such, this type of transaction usually provides a higher return on investment due to lower inventory turnover, more efficient production processes, and a reduction in waste and over-supply due to the localization of labor and costs. However, due diligence is required to ensure that the acquired company meets all of the organizational goals and objectives and that the acquired entity can continue to contribute to the growth and profitability of the larger firm.