Merger vs. Takeover: An Overview

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, 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.

Key Takeaways

  • Mergers and takeovers (or acquisitions) are very similar corporate actions.
  • 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."
  • A takeover, or acquisition, is usually the purchase of a smaller company by a larger one. It can produce the same benefits as a merger, but it doesn't have to be a mutual decision.

Merger

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 value for both groups of shareholders.

A typical merger, in other words, involves two relatively equal companies that 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 had 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 presence in North America.

Takeover

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 shares 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, the 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 takeover, such as including covenants in their bond issues that force early debt repayment at premium prices if the firm is taken over.

Special Considerations

As mentioned, both mergers and takeovers can be funded through the purchase and exchange of stock. This is the most common form of financing. In other situations, cash can be used, or a mix of both cash and equity. In certain instances, debt can be used, which is known as a leveraged buyout, which is most common in a takeover.

Shareholders with common stock have voting rights and can, therefore, vote on whether a merger or takeover happens. In the case of a hostile takeover, when a shareholder's voting rights do not have enough sway, some voting rights contain language that may inadvertently prevent a merger or takeover, such as a poison pill.