A:

In a general sense, mergers and takeovers (or acquisitions) are very similar corporate actions - they combine two previously separate firms into a single legal entity. Significant operational advantages can be obtained when two firms are combined and, in fact, the goal of most mergers and acquisitions is to improve company performance and shareholder value over the long-term.

The motivation to pursue a merger or acquisition can be considerable; a company that combines itself with another can experience boosted economies of scale, greater sales revenue and market share in its market, broadened diversification and increased tax efficiency. However, the underlying business rationale and financing methodology for mergers and takeovers are substantially different.

A merger involves the mutual decision of two companies to combine and become one entity; it can be seen as a decision made by two "equals". The combined business, through structural and operational advantages secured by the merger, can cut costs and increase profits, boosting shareholder values for both groups of shareholders. A typical merger, in other words, involves two relatively equal companies, which combine to become one legal entity with the goal of producing a company that is worth more than the sum of its parts. In a merger of two corporations, the shareholders usually have their shares in the old company exchanged for an equal number of shares in the merged entity. For example, back in 1998, American Automaker, Chrysler Corp. merged with German Automaker, Daimler Benz to form DaimlerChrysler. This has all the makings of a merger of equals as the chairmen in both organizations became joint-leaders in the new organization. The merger was thought to be quite beneficial to both companies as it gave Chrysler an opportunity to reach more European markets and Daimler Benz would gain a greater presense in North America.

A takeover, or acquisition, on the other hand, is characterized by the purchase of a smaller company by a much larger one. This combination of "unequals" can produce the same benefits as a merger, but it does not necessarily have to be a mutual decision. A larger company can initiate a hostile takeover of a smaller firm, which essentially amounts to buying the company in the face of resistance from the smaller company's management. Unlike in a merger, in an acquisition, the acquiring firm usually offers a cash price per share to the target firm's shareholders or the acquiring firm's share's to the shareholders of the target firm according to a specified conversion ratio. Either way, the purchasing company essentially finances the purchase of the target company, buying it outright for its shareholders. An example of an acquisition would be how the Walt Disney Corporation bought Pixar Animation Studios in 2006. In this case, this takeover was friendly, as Pixar's shareholders all approved the decision to be acquired.

Target companies can employ a number of tactics to defend themselves against an unwanted hostile takeovers, such as including covenants in their bond issues that force early debt repayment at premium prices if the firm is taken over.

For more on this topic, check out The Wacky World Of M&As, Bloodletting And Knights: A Medieval Guide To Investing and The Basics Of Mergers And Acquisitions.

RELATED FAQS

  1. Why do economists think it is important to track discretionary income?

    Learn about the importance of discretionary income to economists, particularly for economists who emphasize consumer spending ...
  2. What is the relationship between research and development and innovation?

    Understand what research and development is and why a company or person would want to conduct it. Learn about how it can ...
  3. How is minimum transfer price calculated?

    Discover how to calculate the minimum transfer price for goods and materials that have been transferred between multiple ...
  4. How does neoclassical economics relate to neoliberalism?

    Read about neoliberalism and neoclassical economics, two political and economic movements that argued for lower taxes, less ...
RELATED TERMS
  1. Hunting Elephants

    The practice of targeting large companies or customers.
  2. Precedent Transaction Analysis

    A valuation method in which the prices paid for similar companies ...
  3. Poison Put

    A takeover defense strategy in which the target company issues ...
  4. Enterprise Investment Scheme (EIS)

    A UK program that helps smaller, riskier companies to raise capital ...
  5. Assented Stock

    A share of stock owned by a shareholder who has agreed to a takeover.
  6. Back-End Plan

    An anti-acquisition strategy in which the target company provides ...

You May Also Like

Related Articles
  1. Stock Analysis

    The CVS Target Deal: A Healthy Union?

  2. Investing News

    Most Important Mergers And Acquisitions ...

  3. Investing

    Salesforce Buyout

  4. Entrepreneurship

    Comparing Impact Investing & Venture ...

  5. Investing

    Impact Investing: How it Works and How ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!