What Are Mergers and Acquisitions? (And How They Work)

By Indeed Editorial Team

Published June 4, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

A common large-scale transaction in business is the process of mergers or acquisitions, which can allow companies to change ownership or consolidate their market position. Although both of these transaction types are similar, they are fundamentally different and affect the businesses in various ways. Understanding each of these ownership changes and their benefits and challenges is key to increasing market access and improving profits.

In this article, we explain what mergers and acquisitions are, explain the benefits of each and their types, describe how they work, and investigate the how employees work through these processes.

What are mergers and acquisitions?

Mergers and acquisitions are when a company either merges with or acquires another. These transaction processes are similar, but the nature in which the two companies join determines if it's a merger or acquisition. Below is a description of each to outline how they're similar and why they're different:

What defines a merger?

A merger is when two separate business entities join to become a single organization. In this case, the stocks of each of the merging businesses cease to trade under their prior identity and issue in the name of the new combined entity. This is usually a mutually beneficial arrangement between the two parties. Below are several types of business ownership transactions which are mergers:

  • Product extension merger: These mergers involve two organizations that sell similar products in the same industry and share common supply chains, production processes, and distribution channels. These mergers allow both companies to group their products to gain market access and grow revenue.

  • Market extension merger: This is when two businesses in the same industry but different markets merge to gain more consumers. Usually, these companies sell the same product or service, so the purpose of merging is to gain a larger client base.

  • Conglomerate merger: This is the process of two unrelated businesses joining to share assets, reduce risk, and benefit from growth in scale. Mixed conglomerate mergers help businesses access new markets, while in pure conglomerate mergers, the companies remain in separate markets.

  • Vertical merger: This is a merger between two companies that sell different products but share supply chains. These mergers improve efficiency for both entities.

  • Horizontal merger: These involve the merging of two companies in the same industry. They often occur between two competitors.

What defines an acquisition?

An acquisition, by contrast, occurs when one company absorbs another, including its assets. The acquired business retains its name and structure under the new ownership, although its stock becomes that of buyer, and it ceases to trade stocks under its former name. Takeovers often fall into the classification of acquisition, whereas mergers are mutual ownership ventures. With both acquisitions and mergers, the success of the process depends on the larger company's ability to convince the target business' shareholders to merge or sell their shares.

In investment banking, news of acquisitions and mergers may cause the value of a company's stocks to rise or fall. Below are several types of acquisitions:

  • Speculating acquisition: This is when a larger organization purchases a smaller one to gain growth from its goods or services.

  • Value-creating acquisition: This is when a business purchases another to make a profit, and rather than simply absorbing the company, the buyer aims to resell the business at a higher price afer improving its performance.

  • Resource acquiring acquisition: This involves a company purchasing another to access its resources, like skills, personnel, intellectual property, or market access.

  • Accelerating acquisition: This involves a larger company purchasing a smaller one to increase the market access of the acquired business's products or services.

  • Consolidating acquisition: These are acquisitions where the acquiring business buys another to decrease its competition in the marketplace.

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Benefits of acquisitions and mergers

There are many benefits of acquisitions and mergers in the marketplace, usually relating to a combined business' ability to achieve more, reach further, or dominate competition. Businesses that merge with or acquire others often gain advantages in the economies of scope, scale, and resources. This means that when companies join with others, they often gain the combined abilities and reach of both businesses. Joining companies also means that two competing businesses become a single entity, and so their competitive advantage also combines, which gives them both a stronger hold on their position in the market.

How acquisitions and mergers work

Acquisitions and mergers involve lengthy and usually confidential negotiations between two businesses. Whichever of the organizations is larger commonly initiates the interaction before both engage in deliberations between their respective boards. Below are the steps for how acquisitions and mergers usually work between two businesses:

1. Creation of acquisition or merger strategy

The first step in considering an acquisition or merger is to create a robust strategy for the process you intend to take. This is a vital document that outlines the transaction's purpose. It also states the potential gains for both parties and establishes methods for convincing stakeholders to trade and for raising funding.

2. Developing search requirements

Next, the following step is to determine the criteria for identifying which organizations to target for acquisition or merging. Such requirements may depend on a few fundamental factors of the smaller company. These elements can include their supply chain, geographic spread, market share, product range, or customer base. Such factors help the larger company identify its potential targets.

4. Acquisition planning

After the larger business has identified its potential targets, it makes contact with each to present an initial offer. The target company's response is commonly what determines whether any further transacting is a merger or an acquisition. If the response to this offer is willing and collaborative, they may negotiate a merger. If the company is less willing to join with the intent of working together, then an acquisition may be the remaining option for the larger company.

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5. Valuation

If the target company agrees to merging or acquisition, the acquiring company requests that business' information to review its financial health. This is to gain an understanding of the organization's finances, product performance, and other essential metrics which help the acquirer make informed decisions regarding the progress of this transaction. The valuation stage is key for avoiding unwise business commitments or opening the larger business up to vulnerabilities.

6. Negotiations

Once the two companies agree to transact ownership, either through acquisition or merging, they may begin negotiations. Sometimes, external elements such as the economy, the company's owners, or the current CEOs can influence the speed of these deals. These companies may complete due diligence, which aims to verify the information gained through the valuation stage.

7. Preparation of agreements

Next, both parties can prepare to sign a purchase and sales agreement. This contract transfers the assets or shares from the target business to the acquirer. When the acquirer is purchasing the smaller business's shares, both parties agree on the ratio of target company shares that equal one share of the acquirer's business for the merged entity. Then, the acquirer reveals their plan for financing the purchase transaction.

8. Closing

Closing is a sales term referring to the completion of a sale. This is the final stage of the deal and officially merges the companies according to the guidelines of their agreement. Once the deal is closed, the two companies become one.

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Employees and acquisitions and mergers

Acquisitions and mergers can mean uncertain times for employees who may have many questions regarding their employments security through this process. Below are two main employee considerations when a company is part of a merger or acquisition:

How mergers or acquisitions affect employees

Mergers or acquisitions can have a variety of effects on employees during these sometimes long processes. Some impacts are positive, while some may present opportunities for management to handle their workforce's expectations. Here are some of the key ways in which these processes often impact employees:

  • Uncertainty: The prospect of a business combining with another can make employees wonder if their job may still be necessary when the process is complete.

  • Stock options: In some cases, employees of merged businesses may gain access to stock options for the new entity, which may occasionally result in appreciating stock prices.

  • Culture clash or improvement: When two companies become one, their cultures may sometimes also merge. While this may sometimes present an adjustment challenge, it can also mean an overall improvement of company culture when the benefits of both combine.

Tips for retaining and motivating employees through this process

Here are some tips for keeping employees engaged throughout a merging business process:

  • Communicate effectively: Once employees know that a merging is happening, it's vital to keep communication lines open so you can hear their concerns, share information, and offer support.

  • Give them time: Giving employees enough time to react and plan for any changes can show them that you value their position at the company and hope they can remain through the merger.

  • Recognize and reward: Rewarding hard work at significant milestones or in daily work is a powerful motivator for employees, and communicates that you value them as team members.

  • Focus on team dynamics: Strong teams can provide support in emotional, workload, or personal terms, so encouraging strong team-building can provide an element of security to staff through merging processes.

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