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The Principles Behind Mergers and Acquisitions

Within the world of corporate finance, nothing is more important than mergers and acquisitions. A merger is when two or more companies become one, an acquisition is when one company completely takes over a second one. This is an essential different to understand. Corporate mergers and acquisitions are very interesting to investors. This is because they have a direct effect on the stock value of the companies they invest in. Plus, they have an effect on corporate taxes (favorable or unfavorable).

The Principles Behind Mergers and Acquisitions

The Principles Behind Mergers and Acquisitions

You will probably have heard of the term ‘hostile takeover’, where one company takes over another against their wishes. Usually, this happens by purchasing the vast majority of a company’s stock. Whether hostile or not, the rationale behind these actions is money. Every business’ sole goal is to make more money.

A merger and acquisition can mean more money for the individual parties involved. In a hostile takeover, however, it generally means more money solely for the company that did the takeover. Plus, either way, there are usually some terminations of positions. After all, no business needs two CEOs.

The level of change that happens in mergers and acquisitions varies tremendously. This also depends on the type of merger that happens. The most common ones are horizontal, vertical, market extension, conglomeration and product extension.

Different Types of Mergers

  • In a vertical merger, two companies that manufacture or sell products that work together join forces. For instance, a producer of spark plugs may merge with a company that manufactures engines.
  • In a horizontal merger, two companies that manufacture or sell products in direct competition join forces. For instance, a company that manufactures exercise clothing may merge with another company that also manufactures sporting goods.
  • In conglomerations, two companies that manufacture or sell completely unrelated products join forces. For instance, a company that manufactures children’s toys may join forces with a company that manufactures kitchen appliances.
  • In a market extension, two companies that sell or manufacture the exact same product but who focus on different markets join together. For instance, both companies may produce mayonnaise, but one only markets in Europe, whereas the other markets in Canada.
  • In a product extension, two companies that sell or manufacture related products to the same market join forces. For instance, a company that creates potato chip dips may join with a company that produces potato chips.

As stated, there is a big different between mergers and acquisitions. Within an acquisition, one company buys another using stocks and/or cash, and the first company ceases to exist, whereas the buyer continues. In a merger, both companies cease to exist and create a singular, brand new entity. Often times, because of brand recognition, the new company will incorporate both company names, however.

The reason why this happens, also as stated, is to make more money. The philosophy is that by joining forces, either forcefully or voluntarily, a larger market can be reached, a product can be improved on, and production costs can be reduced.

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