Intro To Mergers & Acquisitions

Intro To Mergers & Acquisitions

A handshake showing a successful merger and acquisition deal completed.

Key Takeaways about Mergers & Acquisitions:

This guide explains what mergers and acquisitions are, how they differ, and goes into some high-level detail about how these deals are structured. This guide is designed to help people unfamiliar with the M&A process understand what mergers and acquisitions are and how M&A works. Here are some key takeaways about mergers and acquisitions:

  • The terms “merger” and “acquisition” are sometimes used interchangeably, but they refer to different things.
  • A merger describes a transaction where a business combines with another business with the intention to operate as a new, combined entity.
  • An acquisition describes a transaction where one business buys all of part of another business’ stock or assets.

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What Are Mergers & Acquisitions?

The term “mergers and acquisitions” refers to the purchase and sale of a business or the consolidation of two or more business entities. In an M&A transaction, a company could acquire another business outright, two companies could merge together creating a new company, or a business could acquire some or all of another business’ assets.

The terms “merger” and “acquisition” are sometimes used interchangeably, but they refer to different things.  

A merger is when a business decides to combine with another business with the intention to operate as a single legal entity. Essentially a merger is a combination of two businesses. Generally, the two companies entering into a merger are equal in size. Often the objective of a merger is for both companies to gain access to a larger market, reduce competition between them, and achieve economies of scale. An example of a merger is when Heinz merged with Kraft in 2015.

The term acquisition refers to when one business buys all or part of another business’ stock or assets. Acquisitions differ from mergers in that mergers are a consolidation of two businesses and an acquisition is when one company takes over another company. Typically, when one business acquires another, the acquired company doesn’t change its name and continues to maintain its own organizational structure, independently of the acquiring business. Often, an acquisition is made to take control of another company in order to eliminate a competitor, or to create financial synergies between them.  An example of an acquisition is when Facebook acquired WhatsApp in 2014, for $22 billion.

To learn more about how the M&A process actually works, we recommend our guide: The M&A Process Explained as a logical companion to this guide.

Understanding The Purchase Price In An M&A Deal:

The first consideration in an M&A deal is how the acquiring business intends to pay the seller. What does the seller get in exchange for their business? Both the purchase price amount as well as the terms of the payment will be negotiated in an M&A deal. How the payment is structured can be a complex agreement with terms that extend years after the deal closes.

There are three main ways payments are structured between the acquirer and the seller: cash, shares of stock, and seller notes. The decision to use either cash, stock, or seller notes is dependent on several factors surrounding the M&A deal.

Cash payments are self-explanatory on their own, but the terms surrounding cash payments may not be so straightforward. Often, a large part of the negotiating process will be dedicated to the terms of the payment. Is the cash payment paid out in full up front? Cash payments don’t need to be structured as up-front payments. They can instead be structured as earnouts. Meaning that the seller could receive a smaller amount up front and the rest of the payment years down the road. Earnouts are usually structured in a way that ties them to future performance standards in the business, meaning that the sellers may not end up receiving the full amount if certain conditions are not met.

Additionally, acquirers can pay the seller with shares of stock. In this case, the seller would receive shares of the acquiring company’s stock as compensation for the deal. These shares can make up the full payment amount (meaning that the seller would receive no cash, only shares­­­­) or they could make up part of the payment and the seller could receive some cash and some stock.

The third main way that the payment in an M&A deal can be structured is through seller notes. This is a form of seller financing. The idea here is to cover the gap between the seller’s required sale price and the amount that the buyer can actually afford to pay them. In essence this is a deferred payment structure where the seller will receive part of the purchase price up front, with the remaining portion paid to them over time. Seller notes are typically unsecured, meaning that the acquirer won’t need to back them with collateral, and usually have a payback term of three to seven years.

An important distinction is that seller notes are different than earnouts. Earnouts are tied to future performance of the business, meaning that if the business doesn’t hit those performance targets, the seller won’t be paid the full amount. Seller notes are a form of seller financing designed to help the acquiring business pay a larger purchase price than they are able to afford now.

Additional Considerations For M&A Deals:

In addition to the purchase price and the terms surrounding the payment, there are additional considerations when doing an M&A deal.

In any M&A deal, there will be accounting and tax implications. These implications can be realized early on, and they can also have implications well into the future. An example of this involves goodwill.

In accounting, goodwill is an intangible asset that goes on a company’s balance sheet. Goodwill is recorded when an acquiring business pays a seller more than the fair market value of their business.

In this event, goodwill can be amortized in some cases, and it can't in others—depending on how the deal is structured. Deals are structured as asset purchases or stock purchases.

Privately held businesses can amortize goodwill regardless of whether the deal is structured as a stock purchase or an asset purchase. If the business is a publicly traded company the structure of the deal will impact the buyer's ability to amortize goodwill. To learn more about goodwill, we recommend our guide: What is goodwill in accounting? To learn more about structuring M&A deals as asset purchases or stock purchases, we recommend our guide: Asset Purchase vs Stock Purchase.

In addition to goodwill and the decision to structure the deal as an asset purchase or as a stock purchase, there are other accounting and tax implications that need to be considered as well.

Major consideration also needs to be given to financial synergies in an M&A deal. Financial synergies are realized when two businesses combine and opportunity is created that was not there before the deal. There are two major categories of financial synergies—revenue enhancements and cost savings. Revenue enhancements are financial synergies that result from the business’ ability to generate more cash flows through more effective use of assets. Cost savings are financial synergies that occur when two companies join forces, and the effect is lowering the costs of doing business through increased operating efficiencies. To learn more about financial synergy in M&A deals, we recommend our guide: Financial Synergy.

Additionally, confidentiality is a major issue surrounding M&A transactions. In almost all cases, the seller will want to keep their identity, and often the fact that they’re looking to sell a secret. There are many reasons for this including a fear of blowback from customers, and the desire to keep sensitive financial and operating information out of the hands of competitors. Consideration needs to be given to protecting the identity of the seller in an M&A transaction.

Typically, this begins with the teaser. When a business is looking to sell, they will put out a teaser. A teaser is a short one- or two-slide summary of financial information that keeps the seller’s identity anonymous. The goal of a teaser is to give potential buyers a snapshot of the company so they can decide if this seller’s business potentially aligns with their acquisition strategy. To learn more about teasers and how they work, we recommend our guide: What is a Teaser in M&A? In addition to the teaser, after the buyer has decided they are potentially interested, and the seller and potential buyer are both open to doing a deal, there will be a formal non-disclosure agreement signed by both parties. To learn more about NDA’s, we recommend our guide: Non-Disclosure Agreements: NDA Meaning & Practice in M&A. Both of these measures are taken to ensure a level of confidentiality in the deal.  

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