Acquisition

What is a Company Acquisition?

An acquisition is a type of corporate transaction in which a company takes over another entity and establishes itself as its new owner. It is a growth strategy that aims to achieve results in the short-term by purchasing businesses that are already well-positioned in their respective markers or fields.

An acquisition takes place when one company takes ownership of another company’s stock, assets or equity. It is a consolidation process that aims to create synergies to increase the profitability of the acquirer.

This concept usually refers to the purchase of a smaller firm by a larger one. In general, acquisitions are friendly procedures. In those cases, the transaction has already received a green light from the target company’s board of directors, employees and shareholders.

This means that the target company agrees with the sale and cooperates with the negotiations. On the other hand, in some cases, an acquisition can be a hostile transaction. This means that the board and/or management of the target company are not willing to sell but the acquirer forces them to do so through different strategies.

An acquisition may be made by stock purchase or by asset purchase. For legal entities such as sole proprietorships, partnerships or Limited Liability Company (LLC), the deal could only be made by asset purchase.

If the business is incorporated, the buyer and seller must decide if he wishes to structure the deal as an asset purchase or a stock purchase. Both types are explained below.

Key Takeaways

Types of Company Acquisitions

There are two main types of company acquisitions: stock and asset purchases. Let’s explain both.

#1 Stock purchase

When the acquirer uses the stock purchase method, it will aim to acquire only the target company’s common shares. This means that the ownership of the business entity is transferred to the buyer. The entity continues to have the same assets and liabilities that it had before the transfer but now all of them are owned by the acquirer.

If the selling company does not have a large number of shareholders, a stock transaction will normally be less complicated and easier than an asset purchase, but, in most cases, it has to be approved by the Board of Directors. When companies conduct a stock transaction, they can avoid state taxes that may apply to asset sales. Depending on the tax rate, this could result in significant savings.

#2 Asset purchase

If the buyer chooses the asset purchase method, it will only own the target company’s assets. These commonly include vehicles, buildings, tools, equipment, and inventory, among other items. In contrast to a stock purchase, the seller of the assets remains the legal owner of the entity, while the buyer purchases specific assets of the company.

The buyer can dictate which assets and liabilities and this limits his exposure to unknown liabilities that could be brought on through a stock purchase. However, it is necessary that the assets sold are re-titled in the name of the buyer. This is not required in a stock transaction.

A major tax advantage of an asset purchase is that the buyer can obtain tax deductions for depreciation and/or amortization. Additionally, with an asset transaction, goodwill can be amortized on a straight-line basis over 15 years for tax purposes.

Due to the application of securities law to stock purchases, some firms prefer acquiring assets as it is a less complicated process. On the other hand, by purchasing assets rather than stock, the buyer avoids the problems presented by minority shareholders who may refuse to sell their shares.

Step-by-step process of a Company Acquisition

The process of a company acquisition involves several detailed and strategic steps, designed to ensure that the acquisition is beneficial for both the acquiring and target companies. Here is a step-by-step overview of this process:

#1 Strategic Planning: The acquiring company identifies its strategic goals and how an acquisition could help achieve these objectives, such as entering new markets, acquiring new technologies, or expanding product lines.

#2 Searching for a Target: Once the strategy is clear, the company searches for potential target companies that align with its strategic objectives. This may involve hiring investment bankers, consultants, or using internal resources.

#3 Initial Evaluation: The acquiring company conducts a preliminary evaluation of potential targets to assess strategic fit, financial health, and potential synergies.

#4 Due Diligence: After selecting a target, the acquiring company undertakes a comprehensive due diligence process, examining the target’s financial statements, legal liabilities, operational systems, and other critical areas in detail.

#5 Valuation: The acquirer evaluates the target’s value using various methods such as discounted cash flow analysis, comparable company analysis, or precedent transactions. This helps in determining a fair price for the acquisition.

#6 Financing the Deal: The acquiring company decides on the financing method for the acquisition, which could include cash, stock exchange, debt financing, or a combination of these.

#7 Making an Offer: Based on the valuation and financing strategy, the acquirer makes an offer to purchase the target company. This usually involves negotiations between both parties.

#8 Negotiating Terms: If the offer is accepted, both parties negotiate the terms of the acquisition, including the purchase price, payment method, and any conditions to be met before finalizing the deal.

#9 Drafting and Signing the Agreement: Once terms are agreed upon, legal documents outlining the details of the acquisition are drafted, reviewed, and signed by both parties.

#10 Regulatory Approval: Depending on the size and scope of the acquisition, regulatory approval from relevant authorities may be required. This step ensures the deal complies with antitrust laws and other regulations.

#11 Closing the Deal: After receiving all necessary approvals, the deal is formally closed. The acquisition is finalized, and the payment is made to the target company’s shareholders.

#12 Integration: Post-acquisition, the focus shifts to integrating the target company into the acquiring company’s operations. This includes merging systems, processes, and cultures to realize the anticipated synergies.

#13 Post-Acquisition Review: Finally, the acquiring company conducts a review to assess the success of the acquisition against its initial objectives and to learn lessons for future acquisitions.

This structured approach helps in mitigating risks associated with acquisitions and maximizing the potential for success.

Acquisition Examples

There are many real-life examples of acquisitions. Some of them were successful business decisions while others were not. Let’s look at two well-known cases in the recent US business history.

In 1994, Quaker Oats bought Snapple for $1.7 billion with the purpose of complementing its Gatorade line with the popular bottled teas and juices produced by Snapple. Just 27 months later, Quaker Oats sold Snapple for just $300 million to Triarc Beverages.

According to some analysts, Quaker Oats failed in managing Snapple’s product lines properly and soon after the purchase, the brand started to lose revenues. Quaker probably failed to properly assess its own capabilities to maintain the success of the target company and this was a clear example of an unsuccessful acquisition.

In 2006, Walt Disney Co. acquired Pixar for $7.4 billion. Pixar was a small but successful business that revolutionized the way animated movies were made. In 2009, the company decided to buy Marvel Entertainment for $4 billion, which dominated the world of superheroes.

Those acquisitions made possible the launch of many movies that resulted in billions of dollars in revenues. That strategy allowed Disney to expand significantly its range of movies and provided massive gains to this globally-recognized corporation. Undoubtedly, these two were successful acquisitions.

Difference between an Acquisition and Merger

The difference between an acquisition and a merger lies in the details of the deal structure, the relationship between the involved companies, and the outcome of the transaction:

Acquisition

An acquisition occurs when one company, the acquirer, purchases another company, the target. In an acquisition, the acquirer gains control of the target company, which may continue to exist as a subsidiary or have its operations fully integrated. The identity of the acquired company may or may not be maintained, and the transaction can be friendly or hostile.

Merger

A merger involves two companies combining to form a new entity, with both companies ceasing to exist in their previous forms. The companies involved in a merger are typically of similar size and agree mutually to the merger, aiming to pool their resources, eliminate competition, or achieve synergies.

The result is a new company with a new identity, jointly owned by the shareholders of the original companies.

In essence, the key distinction is that an acquisition involves one company taking over another, while a merger is the combination of two companies into a new entity.

Acquisition  Advantages

An acquisition is assumed to bring more benefits than costs.

Some of the advantages that of completing an acquisition for the acquirer are the following: economies of scale if the enlarged size gives the acquirer the possibility to secure lower prices of its raw materials, access to new distribution channels, reduced labor costs when it some of the staff is laid off due to redundant position in the organizational structure, and an enhanced financial situation that may result in a lower cost of capital.

Acquisition Disadvantages

Any acquisition carries costs. Money has to be spent in legal and consulting expenses and also a lot of time is employed by senior managers to make sure the deal is completed successfully.

Aside from that, absorbing another company may bring cultural differences that should be assessed and reduced as soon as possible. Additionally, when there is a modification in the brands, products, or distribution channels, there is a risk that consumers may react negatively to the changes introduced.

Bottom Line

An acquisition is a transaction in which a company buys another firm partially or completely. In most cases, a larger company purchases the assets or the equity of a smaller firm.

When acquiring a firm, the acquirer expects to create synergies and grow quickly. It foresees a scenario of expanded markets, reduced costs and wider product lines, among other benefits.

However, the potential advantages must be analyzed carefully before making the decision as an acquisition is a process that also comes with difficulties and costs. Not all acquisitions result in a better situation from the acquirer’s perspective as shown in the example outlined above.

Frequently Asked Questions

What constitutes a successful company acquisition?

A successful company acquisition is characterized by the seamless integration of the target company, realization of anticipated synergies, and achievement of strategic objectives that enhance shareholder value.

How do companies finance acquisitions?

Companies finance acquisitions through various means, including cash reserves, issuance of new equity, debt financing, or a combination of these methods, depending on their capital structure and strategic goals.

What role does due diligence play in the acquisition process?

Due diligence is a critical phase in the acquisition process where the acquiring company thoroughly examines the target company’s financials, operations, legal standing, and potential risks to ensure an informed investment decision.

Can an acquisition affect the stock prices of the involved companies?

Yes, an acquisition announcement can affect the stock prices of both the acquiring and target companies, typically leading to an increase in the target’s stock price and a variable impact on the acquirer’s stock price, depending on investor perception of the deal’s value.