What is Business Acquisition?
Business acquisition is the process of acquiring a company to build on strengths or weaknesses of the acquiring company. A merger is similar to an acquisition but refers more strictly to combining all of the interests of both companies into a stronger single company. The end result is to grow the business in a quicker and more profitable manner than normal organic growth would allow.
Acquisitions are typically made in order to take control of, and build on, the target company’s strengths and capture synergies. There are several types of business combinations: acquisitions (both companies survive), mergers (one company survives), and amalgamations (neither company survives).
An acquisition is when one company purchases most or all of another company’s shares to gain control of that company. Purchasing more than 50% of a target firm’s stock and other assets allows the acquirer to make decisions about the newly acquired assets without the approval of the company’s shareholders. Acquisitions, which are very common in business, may occur with the target company’s approval, or in spite of its disapproval. With approval, there is often a no-shop clause during the process.
We mostly hear about acquisitions of large well-known companies because these huge and significant deals tend to dominate the news. In reality, mergers and acquisitions (M&A) occur more regularly between small- to medium-size firms than between large companies.
Why Make an Acquisition?
Companies acquire other companies for various reasons. They may seek economies of scale, diversification, greater market share, increased synergy, cost reductions, or new niche offerings. Other reasons for acquisitions include those listed below.
As a Way to Enter a Foreign Market
If a company wants to expand its operations to another country, buying an existing company in that country could be the easiest way to enter a foreign market. The purchased business will already have its own personnel, a brand name, and other intangible assets, which could help to ensure that the acquiring company will start off in a new market with a solid base.
As a Growth Strategy
Perhaps a company met with physical or logistical constraints or depleted its resources. If a company is encumbered in this way, then it’s often sounder to acquire another firm than to expand its own. Such a company might look for promising young companies to acquire and incorporate into its revenue stream as a new way to profit.
To Reduce Excess Capacity and Decrease Competition
If there is too much competition or supply, companies may look to acquisitions to reduce excess capacity, eliminate the competition, and focus on the most productive providers.
To Gain New Technology
Sometimes it can be more cost-efficient for a company to purchase another company that already has implemented a new technology successfully than to spend the time and money to develop the new technology itself.
The process begins with defining the type of business that would make a good acquisition. Generally businesses within the same segment or a highly complementary market segment are targeted. Once defined the target business is approached and if interest is shown due diligence is performed to ascertain the financial and other conditions of the business.
When the financial terms are agreed upon, and the contract is signed the merger portion of the acquisition begins. Overlapping processes, personnel and products are evaluated and the better-performing pieces are retained.
Evaluating Acquisition Candidates
Before making an acquisition, it is imperative for a company to evaluate whether its target company is a good candidate.
- Is the price right? The metrics investors use to value an acquisition candidate vary by industry. When acquisitions fail, it’s often because the asking price for the target company exceeds these metrics.
- Examine the debt load. A target company with an unusually high level of liabilities should be viewed as a warning of potential problems ahead.
- Undue litigation. Although lawsuits are common in business, a good acquisition candidate is not dealing with a level of litigation that exceeds what is reasonable and normal for its size and industry.
- Scrutinize the financials. A good acquisition target will have clear, well-organized financial statements, which allows the acquirer to exercise due diligence smoothly. Complete and transparent financials also help to prevent unwanted surprises after the acquisition is complete.
Single Business Acquisitions and Split and Sell
A single acquisition refers to one company buying the assets and operations of another company and absorbing what is needed while simply discarding duplicated or unnecessary pieces of the acquired business. “Split and sell” acquisitions involve buying an entire business in order to gain one or two pieces of the business. The acquiring business may wish to retain the customer list and a product line, while moving manufacturing and other production related duties to an existing line. In this case the excess is often sold off to recapture some of the acquisition cost.
There are many risks related to business acquisition and a number of mergers or acquisition fail ending up inducing higher operating costs. There are a set of criteria that are usually followed to know if a business is a good target for acquisition such as: having operative processes, a profitable and documented customer acquisition strategy, good profits, a good customer retention strategy, etc.
Example of an Acquisition
An acquisition is commonly mistaken with a merger – which occurs when the purchaser and the target both cease to exist and instead form a new, combined company.
When a target company is acquired by another company, the target company ceases to exist in a legal sense and becomes part of the purchasing company. Acquisitions are commonly made by using cash or debt to purchase outstanding stock, but companies can also use their own stock by exchanging it for the target firm’s stock. Acquisitions can be either hostile or friendly.
Let’s assume Company XYZ wants to acquire Company ABC. Company XYZ starts to buy ABC shares on the open market, but once Company XYZ acquires 5% of ABC, it must formally (and publicly) declare to the Securities and Exchange Commission (SEC) how many shares it owns. Company XYZ must also state whether it intends to buy ABC or just hold its existing shares as an investment.
If Company XYZ wants to proceed with the acquisition, it will make a “tender offer” to ABC’s board of directors, followed by an announcement to the press. The tender offer will indicate, among other things, how much Company XYZ is willing to pay for ABC and how long ABC shareholders have to accept the offer.
Once the tender offer is made, ABC can accept (1) the terms of the offer, (2) negotiate a different price, (3) use a “poison pill” or other defense to avert the deal, or (4) find another company, who hopefully will pay as much or more as XYZ is offering, to buy them.
If ABC accepts the offer, regulatory bodies then review the transaction to ensure the combination does not create a monopoly or other anti-competitive circumstances within the industries involved. If the regulatory bodies approve the transaction, the parties exchange funds and the deal is closed.
- The acquisition is a time-efficient growth strategy that helps the Company to acquire the core competencies and resources which are not currently available. The Company can instantaneously enter into a new market, product and overcome the barriers of entry. Further, it will not have to invest much time and effort in product development.
- The acquisition provides market synergy by quickly building the market presence of the Company. The Company can increase its market share and reduce competition. It can further build on its brand through acquisitions.
- The acquisition can improve financials and give short term gains when an organization with low share price are acquired. Synergies can improve cost cuttings as well as provide efficient use of resources.
- Acquiring other businesses and entities reduces barriers to entry. The Company can overcome the market entry barrier in no time and hence reduce the market research, product development costs.
- Acquisitions provide confidence in the Company and can boost shareholders morale and confidence in their Company. Shareholders may expect the Company to buy or acquire other Companies which may increase the share price and yield higher returns for them.
Disadvantages and Limitations
- Every acquisition comes with a cost, at times the cost can be higher than anticipated. In such a case acquiring Company can take higher debt and increase its debt to equity ratio. Also, if the expected synergies are not met, the Company can lose out on the acquisition.
- Returns to the shareholders may not be as expected. Acquisition in general takes time and it may take more time to integrate the two companies. Thus, shareholders may not get the expected returns on their investment from the acquisition.
- The integration of two companies has their own challenges especially managing the employees’ expectations. Cultural issues arise when employees of the two
- Companies meet. The new methods and activities may take time to settle with the old employees of the Company which may raise anxiety and integration challenges.
If the integration is of unrelated products and services the employees will have further challenges to understand the work, market, and competencies.
- If the acquisition management is not done properly this may lead to disruption of business and failure of the motive for which the acquisition was done in the first place. The Company should have enough managerial resources who have first-hand experience in acquisitions and thus they should be able to manage the employees, work, operations and successfully integrate the two businesses.
When a company is looking to expand, one way many business owners consider doing so is through the acquisition of another similar business. An acquisition is a great way for a company to achieve rapid growth over a short period of time. Companies choose to grow through M&A to improve market share, achieve synergies in their various operations, and to gain control of assets. It is less expensive, less risky, and faster, as compared to traditional growth methods such as sales and marketing efforts.
While an acquisition can create substantial and rapid growth for a company, it can also cause some problematic issues along the way. Several things can go wrong even when there is a well-laid plan. There may be a clash between the different corporate cultures, synergies may not match, some key employees may be forced to leave, assets may have a lower value than perceived, or company objectives may conflict.
Before putting the acquisition of another business into consideration, it is essential to analyze the advantages and disadvantages that will be presented by the business deal. A well-executed strategic acquisition that takes advantage of potential synergies can be one of the best ways for a company to achieve growth.