All businesses strive to grow and expand. There are broadly two ways a business can get bigger, either through internal growth or external expansion. The internal growth is through the regular growth path of an entity, by use of advanced technology, acquisition of assets, better supply chain management and new lines of product among many other techniques. However hard the company may try, this path takes its natural course and time to reap results. The other way companies look to grow is by exploring the option of corporate restricting which is done by mergers, takeovers or acquisitions. The external path way of growth is very popular among companies globally as it helps in crossing trade barriers, enable free of capital across countries and combats the increased globalized competitiveness.
Mergers are combinations involving at least two companies. The result of a merger could be the dissolution of one of the legacy companies and the formation of a brand new entity. The boards of the companies involved must approve any merger transaction. Stockholders may receive stock, cash or a combination of cash and stock during a merger.
- Companies in stock-for-stock mergers agree to exchange shares based on a set ratio. For example, if companies X and Y agree to a 1-for-2 stock merger, Y shareholders will receive one X share for every two shares they currently hold.
- Y shares will cease trading and the number of outstanding X shares will increase following he completion of the merger.
- The post-merger X share price will depend on the markets assessment of the future earnings prospects for the new entity.
- The share prices immediately following the merger announcement usually reflect the exchange ratio, fears of dilution and prospects for a smooth integration.
- If X and Y shares are trading at $20 and $8 pre-merger, respectively, X shares may drop to $18 after the merger announcement because of dilution fears, and Y shares may rise to $9 to reflect the exchange ratio.
- In cash mergers or takeovers, the acquiring company agrees to pay a certain dollar amount for each share of the target company’s stock. The target’s share price would rise to reflect the takeover offer. For example, if company X agrees to pay $100 for each share of company Y, the share price of Y would rise to about $100 to reflect the offer.
- The price could rise even further if additional companies are interested in acquiring Y.
- However, the X’s shareprice could initially fall if investors are unconvinced about the strategic value of the merger. After the companies merge, Y shareholders will receive $100 for each share they hold and Y shares will stop trading.
- Some stock mergers result in a new entity. For example, companies X and Y could merge to form New Company, with X and Y shareholders receiving New Companies shares based on their prior holdings.
- Merger agreements sometimes give shareholders a choice of receiving stock, cash or both.
- For example X could offer Y shareholders the option of receiving $20 in cash, one X share for every two Y shares they now hold, or a combination of $10 in cash and 0.33 X shares for each Y share.
- A reverse merger is when a public company – usually operating as a shell company with limited operations – acquires a private company, which secures access to the capital markets without having to go through an expense initial-public offering process. The acquired company’s shareholders and management exchange their shares for a controlling interest in the public company, hence the terms “reverse merger” or “reverse takeover”.
A merger or acquisition is one of the most significant corporate events for a company, stamped in its history forever. Amidst an atmosphere of increased competitiveness, the strategy of merger and acquisitions is common for small as well as large businesses. The intension behind such a move or decision is unique to every business, but is based on the principle of creating more value (after combining) than the individual companies are worth individually. The additional value created by the merger or acquisition process is called synergy. Though it sounds simple, but the whole process of a merger, takeover or acquisition to create synergy (financial benefit) is daunting, with large sum of money, paper work, government regulations, and legalities and accounting procedures involved.