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Mergers and acquisitions are deals in which two firms combine in some way. Although the terms “merger” and “acquisition” are used interchangeably, they have distinct legal implications. A merger is the joining of two firms of equal size to establish a new single company.

An acquisition, on the other hand, occurs when a larger corporation acquires a smaller company, absorbing the smaller company's operations. M&A transactions can be friendly or hostile, depending on the target company's board of directors' consent.

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Motives for Mergers and Acquisitions (M&A)

Mergers and acquisitions (M&A) can occur for a variety of reasons, including:

Creating synergy

Mergers and acquisitions (M&A) are commonly used to produce synergies that result in the merged firm being worth more than the two companies independently. Synergies can result from cost savings or increased income.

Cost synergies are generated through economies of scale, whereas revenue synergies are often generated through cross-selling, increased market share, or higher pricing. The cost  synergies are the easier to quantify and calculate of the two.

Greater expansion

Inorganic growth through mergers and acquisitions (M&A) is typically a faster technique for a firm to acquire larger sales than organic growth. A corporation can benefit by purchasing or merging with a company that has cutting-edge skills, rather than taking the risk of developing them internally.

Increased market power

In a horizontal merger, the new business gains a larger market share and the ability to influence prices. Vertical mergers also result in increased market power since the firm has greater control over its supply chain, avoiding external supply disruptions.

Diversification

Companies in cyclical sectors recognize the need to diversify their cash flows in order to prevent major losses during an industry slump. A corporation can diversify and decrease market risk by acquiring a target in a non-cyclical industry.

Tax advantages

Where one firm has a large taxable income and another has a tax loss carryforward, tax advantages are considered. When a firm with tax losses is acquired, the acquirer can utilize the tax losses to reduce its tax burden. However, mergers are rarely done only to avoid taxes.

Types of Acquisition

Mergers and acquisitions (M&A) are classified into two types:

Stock purchase

In a stock acquisition, the acquirer pays the target business's shareholders cash and/or shares in return for the target company's shares. In this case, the target's shareholders receive compensation rather than the target itself. Certain factors must be addressed while purchasing stock:

  • The buyer absorbs all of the target's assets and liabilities, even those that are not on the balance sheet.
  • To obtain the acquirer's pay, the target's shareholders must accept the acquisition by a majority vote, which can be a lengthy procedure.
  • Because they get the remuneration directly, shareholders face the tax responsibility.

Asset purchase

The acquirer purchases the target's assets and pays the target directly in an asset buy. Certain factors must be addressed while purchasing an asset, such as:

  • Because the acquirer just buys the assets, it avoids taking on any of the target's obligations.
  • Unless the assets are considerable, no shareholder approval is normally necessary because the payment is given straight to the target (e.g., greater than 50 percent of the company).
  • The target's compensation is taxed as capital gains at the company level.

Valuation of Mergers and Acquisitions (M&A)

The valuation process in an M&A transaction is carried out by both the acquirer and the target. The acquirer will seek the lowest possible price for the target, while the target will seek the greatest possible price.

As a result, valuation is an essential component of mergers and acquisitions (M&A), as it directs the buyer and seller to the ultimate transaction price. The following are the three primary valuation approaches used to value the target:

  • Discounted cash flow (DCF) method: The target's value is determined by its future cash flows.
  • Comparable company analysis: The target's worth is determined using relative valuation criteria for public enterprises.
  • Comparable transaction analysis: The target's worth is determined using valuation parameters from previous similar deals in the industry.

Conclusion

Mergers and acquisitions (M&A) are transactions in which the ownership of a company or its operational units is transferred to another organization, including all related assets and liabilities. A merger happens when two entities combine into one, whereas an acquisition occurs when one entity acquires ownership of another. M&A allows firms to grow or shrink, as well as modify their competitive position.

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