Companies eventually evolve and strive for improved operations or growth by combining their resources and efforts with other companies. Sometimes, the legal requirement for spinning off specific productive assets involves Mergers and acquisitions (M&A) and divestitures, both of which may entail structural modifications to underlying business via the sale or purchase of the entire company or its parts.
What Exactly Are Mergers and Acquisitions?
Mergers and acquisitions is an umbrella term used for describing the consolidation of assets or companies via different kinds of financial transactions, such as acquisitions, mergers, consolidations, asset purchase, management acquisitions, and tender offers.
With an acquisition, one company acquires another company by purchasing its assets. This means that the acquired company ceases to exist as a business or corporate body. The acquiring company, however, can use the acquired business’s name. With a merger, two companies merge assets to create a new entity or company. Mergers are widespread in cases where both companies have similar power and size.
From a legal standpoint, mergers are reasonably straightforward since there’s typically just one bidder, and stock is used as payment. All shareholders of both companies will need to approve the merger.
The Different Types of Mergers and Acquisitions
M&As are categorized by the attitudes of all involved parties, their structural impacts, and the transaction’s specific mechanisms. Generally speaking, the most common ways that businesses merge to leverage advantages in their target markets include:
- Horizontal Merger: With a horizontal merger, two companies with the same business merge. For example, two clothing companies merge, or one of them acquires the other.
- Vertical Merger: A vertical merger entails a company merging with a customer or supplier. For example, when a retailer merges with a wholesaler or when a construction company purchases a brickyard or lumberyard.
- Conglomerate Merger: A conglomerate merger involves two companies with unrelated businesses merging, such as when an electronics company merges with a steel mill or an insurance company purchases a restaurant chain.
Acquisitions can be hostile or friendly, depending on either party’s attitudes toward the transaction. For example, in a friendly acquisition or merger, both companies willingly enter into the transaction and negotiate accordingly.
On the other hand, hostile mergers and acquisitions are usually spearheaded by dissident stockholders or raiders who buy in first to get a share. In such cases, the target company might have a significant amount of money, might be paying thin dividends, or might (as the hostile bidder believes) be more in favor of growth rather than stockholder return.
In addition, the management teams cooperate well when communicating with stockholders during friendly acquisitions. By contrast, in hostile acquisitions, the acquiring party usually solicits the target stockholder’s votes to get good votes for the transaction to succeed.
The Advantages and Disadvantages of Mergers and Acquisitions
There are many reasons why many companies prefer external growth via mergers rather than internal development. However, as with all business strategies, M&As have advantages and disadvantages.
- Increased corporate power.
- Helps in diversification, including operational and cyclical impacts.
- Improves product lines and market shares.
- Helps the company’s capacity to raise funds when it combines with another company that has low debt and significant assets.
- Offers a great return in investment (ROI) if the acquired company’s market value is substantially less than the cost of replacement.
- Improves the stock’s market price, which may result in a higher price-to-earnings (P/E) ratio.
- Helps the company in funding acquisitions that it wouldn’t have been able to acquire otherwise
- Offers a missed attribute, such that the company obtains something it lacked.
- Achieves a tax loss carryover or carryforward benefit when the acquired entity has been losing profit.
- The dividends that individual shareholders receive are taxable fully, while the capital gains from mergers will not be taxed until the sale of the shares. Likewise, the amounts remitted from the acquired company to the acquiring company will not be taxed.
- The possibility of reverse synergy, which can decrease the combined entity’s net value. For example, the servicing costs of acquisition debt, pay scale adjustments, and defections acquired key company staff, among others.
- Antitrust action that may thwart or delay the proposed merger.
- Negative financial consequences because the expected benefits, such as anticipated cost reductions, failed to materialize.
- Issues deliberately caused by dissenting stockholders.
What Exactly is a Divestiture?
Divestiture is the complete or partial disposal or sale of a product line, business unit, division, or subsidiary. In most cases, divestiture is considered an accepted growth strategy instead of diversification. It entails the total or partial disposition, conversion, and reallocation of money, people, plants, inventories, products, and equipment.
The main objective of divestiture is to eliminate a business segment so that the freed resources can be utilized for some other, more beneficial, and profitable purpose. Business segments are usually prime candidates for divestiture when they:
- Don’t generate adequate cash flow
- Don’t produce a sufficient return on investment
- Are unrelated to the company’s main business lines
- Don’t fit in with the business’s overall corporate strategy
- The value of the pieces is higher than if they were whole
- Don’t meet the goals set by management, such as profit growth and sales, among others.
Divestitures help correct strategic business mistakes. They can help companies refocus on their core businesses, mitigate over-diversification, ensure that the company is in line with its corporate strategy, and eliminate negative synergies.
Get Legal Advice from Virginia Business Lawyers at McClanahan Powers, PLLC
Businesses planning on expanding their interests and exploring resources via mergers, acquisitions, or divestitures would benefit from working with skilled legal partners who could help them mitigate the risks usually linked to such business transactions.
With help from our experienced Virginia business lawyers of McClanahan Powers, PLLC, we can explore and develop innovative strategies that will protect your interests and meet your specific business objectives. For more information on how our business lawyers in Virginia can help, call our office at 703-520-1326 or fill out our online form to arrange your appointment.