M&A transactions can be characterized in a number of ways. These different characterizations provide important context for discussions of the transaction process, regulatory compliance, and the strategic and financial impact of the different types of transactions.
Mergers Versus Acquisitions
The term “merger” technically means the absorption of one corporation into another corporation. Typically, in a merger, the selling corporation’s shareholders receive stock in the buying corporation. However, the term “merger” is frequently used more loosely—for example, to include a consolidation that is technically the combination of two or more corporations to form a new corporation.
In a true merger (as opposed to an acquisition), the acquirer becomes directly liable for all the liabilities of the acquired corporation, often an undesirable result. In a pure stock purchase or acquisition, the acquired company can be kept as a separate subsidiary and, while its liabilities continue to exist, they do not become legal claims against the assets or earnings of the acquirer. However, assumption of liabilities by the acquirer can be avoided by a special structure known as a triangular merger, in which the acquirer sets up a subsidiary and then merges it with the acquired company.
Large Public Versus Small Private Acquisitions
Arguably, the most important distinction among types of acquisitions revolves around size. Merger stat data confirms that a reasonable dividing line between large, public company acquisitions and small, nonpublic acquisitions, as determined by magnitude of purchase price, is $500 million. This is because the vast majority of transactions that are larger than $500 million involve the sale of a public company, and those falling below that benchmark are sales of private companies or divestitures of business units by larger companies.
This distinction is important because large transactions have dynamics and requirements that are substantially different from those of smaller transactions, and those differences have a significant impact on the acquisition process for each. These differences and their impact are briefly described in the paragraphs that follow and are illustrated in the following chart:
- Strategic Impact. Large public transactions are almost invariably transformational in nature. They involve the combination of two large entities that can be expected to have strong positions in the same or adjacent markets. Such combinations generally result in an entity of great size, with substantially expanded product breadth and depth, market reach, and overall capabilities. In contrast, smaller transactions are generally non-transformational in nature and fulfill important, but limited, strategic objectives. While they may materially advance the strategic position of the acquirer, they rarely are significant enough to transform the acquirer’s business.
- Regulatory Requirements. The acquisition of a publicly traded company is heavily regulated by the Securities and Exchange Commission (SEC), state law, and federal antitrust statutes, specifically the Hart-Scott-Rodino (HSR) Act. Nonpublic transactions, in comparison, are minimally regulated. However, those with a purchase price of more than $53 million (periodically adjusted for inflation) may be subject to the provisions of the HSR. In any event, the greater the need for regulatory compliance, the greater the need for additional expertise and resources and the greater the length of time needed to execute the transaction.
- Stock or Asset Purchases. As noted, when publicly traded companies are acquired, it is the shares of those companies that are almost invariably purchased. As a result, all the liabilities of the acquired company are assumed as well. Although the acquirer may be able to shield itself from direct exposure to those liabilities, the acquired entity is still liable for all obligations known and unknown to the acquirer. Frequently, in contrast, selected assets of nonpublic companies are acquired, in lieu of stock. This may enable the buyer to pay for only those assets it truly wants and to avoid assuming many of the target company’s liabilities.
- Leverage of the Parties to the Transaction. In acquisitions of publicly traded companies, pricing leverage will generally reside with the seller. Even as rumors that the target company is being pursued by a suitor emerge, the value of its stock will invariably increase. This among other factors will affect the negotiated price of the shares. If successful in executing a transaction, the acquirer will pay a premium that historically has been within a range of from 30 to 40% above the pre-acquisition price. In contrast, transaction leverage is generally tilted toward the buyer at the small end of the market, particularly when the field of potential buyers is small. This has significant implications regarding price as well as other major terms of the transaction.
- Risk Profile of the Transaction. There is an inverse relationship to leverage and risk. Accordingly, the risk profile of the acquisition of a publicly traded company is quite high. A large body of research has been conducted that indicates that a high percentage of public transactions never generate returns that would justify the price paid. This fact is generally attributable to two factors: synergies generated from the combination are not sufficient to justify the purchase premium paid, and the challenges of integration associated with a transaction of this magnitude are frequently not fully anticipated, adequately prepared for, and effectively executed. In addition, transaction risk is elevated because the acquirer has no recourse for breaches of representations and warranties subsequent to the consummation of the transaction. Private transactions generally allow for a much greater mitigation of risk. This includes measures such as the ability to negotiate price and minimize premiums, the possibility to purchase only selected assets, the ability in many cases to perform more intensive due diligence, and much greater recourse in the case of breached representations and warranties. It is particularly noteworthy that less than 10% of the transactions executed are those in which a publicly traded company is purchased, with smaller, private transactions accounting for the rest. The differences cataloged in the preceding paragraphs make it clear that transaction characteristics are strongly influenced by the size and nature of the entity being acquired. They potentially impact most major aspects of the acquisition process—ranging from negotiation of terms, to regulatory compliance, financing, due diligence, and contract and close.
Strategic Versus Financial Acquisitions
The discussion to this point has focused on strategic acquisitions, those involving a buyer motivated by strategic considerations, such as the objectives listed in the introductory section of this chapter. However, when investment capital is plentiful, venture capital firms (i.e., financial buyers, to be distinguished from strategic buyers) are very likely to become major competitors in the acquisition arena. Rather than buy with the intent to build an enterprise for the long term, these private equity firms acquire properties for the short to midterm and, after investing, repositioning, and combining them with other synergistic assets, will resell them to strategic buyers. Although the discussion herein is biased toward strategic acquisitions, many of the same principles and procedures presented have equal application to financial acquisitions.
Portfolio Acquisitions Of Holding Companies
Acquisition-based holding companies buy companies in diverse industries, based more on the quality of the company, its products, and its management than any overriding strategic approach to a specific market.
Although more common in the 1960s, a time when the concept of the “conglomerate” was in vogue, such organizations are relatively rare in the current environment. By definition, such organizations make acquisitions with no expectation of realizing synergies and no intent to integrate operations. The properties are generally acquired along with their management teams and are run with the intent of building value over the long term. A notable (and extremely successful) example of such an organization is Berkshire Hathaway, the company founded and built by Warren Buffett.
Other Characterizations Of Acquisitions
Other characterizations of acquisitions cross the lines established by the distinctions just made. There are “roll-up” strategies employed by both strategic and financial buyers wishing to expand size and reach, and realize greater scale and efficiency, in a particular niche market. Similarly, there are also “fold-in” strategies employed by buyers, whether strategic or financial, wishing to fill gaps in their offerings by acquiring relatively small companies (or their assets) that can be easily assimilated into the buyer’s operation, while shedding the support infrastructure of the company being acquired.
Divestitures Versus Sales Of An Entire Business
It is important to distinguish between divestitures and sales of entire enterprises, because they have substantially different transaction dynamics. Divestitures entail disposals of a segment of a business such as a business unit, a product line, or even an individual product. They are made either for strategic reasons or for financial reasons. In the case of the former, the unit being sold is deemed by the parent company to no longer be compatible with its strategic direction and therefore not a candidate for continued investment. In the latter case, the sale is invariably made to generate needed cash and is generally executed by a parent that is under financial duress.
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