Mergers are corporate transactions in which two or more companies combine to form a single organization. An acquisition occurs when a larger corporation buys a smaller company and absorbs its business. M&A deals can be friendly or hostile, depending on the target company’s board of directors’ consent.

Types of Mergers

The three basic types of mergers are horizontal, vertical, and conglomerate mergers.

Horizontal Mergers – Companies at similar positions in the value chain of the same industry combine operations in a horizontal merger to cut costs, expand product options, or eliminate rivalry. To attain economies of scale, many of the largest mergers involve horizontal mergers.

Vertical Mergers – In a vertical merger, a company buys another company in the same industry, usually at a different level of the production or sales process. The acquiring firm gains additional control by purchasing a raw material source, a distribution company, or a customer.

Conglomerate Mergers – To lessen risk, a conglomerate merger brings together enterprises in unrelated industries. Combining companies with products that have varied seasonal patterns or respond to business cycles in various ways can result in more steady revenue.

Types of Acquisitions

Stock and asset purchases are the two most common types of acquisitions.

Stock Purchase – The acquirer pays the target firm’s shareholders cash and/or shares in exchange for target company shares in a stock purchase. The target’s shareholders, not the target, get compensated in this case. The acquirer takes on all of the target’s assets and obligations.

Asset Purchase – The acquirer purchases the target’s assets and pays the target directly in an asset buy. Because the acquirer just buys the target’s assets, it won’t have to take on any of the target’s obligations.

Motives behind Mergers and Acquisitions

Mergers are frequently pursued with a strategic purpose in mind; usually to improve the merged firm’s overall performance through cost savings, the elimination of overlapping operations, greater purchasing power, higher market share, or reduced competition.

Financial restructuring takes place during mergers resulting in cutting costs, selling off units, laying off personnel, and refinancing the company to raise its value to shareholders. Buying a business can also be a more convenient, risk-free, and cost-effective choice than developing goods or markets in-house or growing globally.

The acquirer and the target both execute the valuation process in an M&A transaction. The acquirer will seek to secure the best deal on the target, while the target will also want the best deal. Thus, valuation is a key component of a M&A transaction, as it assists the buyer and seller in determining the final transaction price.

This normally consists of two steps: valuing the target on its own and valuing the deal’s potential synergies.

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