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Mergers and acquisitions: Definition, types and processes

Two businessmen shake hands as a symbolic gesture for a mergers & acquisitions process

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Today, companies find themselves in an environment that is subject to constant change and incessant upheaval. In view of this fact, they are increasingly subject to efficiency and innovation pressures. Only those who can adapt and keep pace with the constantly changing environmental and competitive conditions can remain competitive at all. Companies have various means at their disposal to achieve this. One of these promises particularly high and, above all, rapid success: mergers and acquisitions (M&A). But what is the Mergers and acquisition definition in the context of today's world? What types of mergers and acquisitions are there? Why do mergers and acquisitions often fail?

Mergers and acquisitions definition and background

The term "Mergers & Acquisitions", abbreviated to "M&A", first found its way into linguistic usage in the USA at the end of the 19th century. At that time, from 1895 to 1904, a major takeover wave occurred in the USA: numerous companies or company shares were taken over by other companies in turn. This took place either through mergers or acquisitions. Since then, these two corporate activities have been grouped together under the term M&A. Here they are explained in more detail:

  • Mergers are the combination or amalgamation of two or more legally independent companies to form a single legal and economic entity.
  • Acquisitions refer to the purchase of a company or, from the supplier's point of view, the sale of a company. While the buyer receives the entire company or shares in the company, the seller is compensated with a purchase price payment or shares in the buyer.

Common to both transactions is that there is a transfer of ownership rights or a transfer of management and control rights.

However, the term M&A also covers all processes and procedures associated with the merger of companies or the purchase of companies or company shares. These can be, for example, measures for internal restructuring or financing measures.

Motives for M&A

With mergers and acquisitions, companies generally want to achieve two things: One is to secure the company's existence and the other is to grow the company.

In terms of corporate growth, M&As offer a particularly high promise of success. This is because the merger of companies or the purchase of companies significantly increases sales, company size, market shares and market power within a short period of time. Measures for purely internal growth generation cannot achieve comparable success.

Chart showing the growth through mergers & acquisitions
Mergers and acquisitions definition: With M&A, companies generally want to achieve two things: One is to secure the company's existence and the other is to grow the company.

Types of mergers and acquisitions

There are three types of M&A transactions. They are called horizontal, vertical and conglomerate integrations. Following is a brief explanation of each:

Horizontal integrations

Horizontal integrations are spoken of when two companies merge that are to be classified at the same processing or trading level. In other words, the two companies offer the same products or services. Their merger leads to an expansion of their range of products and services.

Vertical integration

In turn, when two companies merge that belong to different processing or trading levels, i.e. offer different products or services, but are either suppliers or customers of each other, this is referred to as vertical integration. The companies involved intended their merger to bundle their sales efforts in one market.

Conglomerate integrations

Finally, business combinations are referred to as conglomerate integrations if the companies involved belong to completely different business areas. Thus, they are neither competitors in the same relevant market, nor are the suppliers or customers of each other.

Furthermore, a distinction can be made between mergers by absorption and mergers by new formation. In the former, the company that has been acquired loses its existence. All its assets, including its debts, are integrated into the acquiring company. In a merger by new incorporation, a completely new company is created as a result of the merger.

Merger and acquisition process

The process of mergers and acquisitions can be described as follows:

  1. When a company wishes to undertake a merger or acquisition, the respective process begins with the search for a suitable company - the target company.
  2. This is followed by an evaluation phase in which the acquiring company very carefully examines the strengths and weaknesses of the target company, weighs up the possible risks of a purchase or merger, and determines and sets the transaction value. This phase is also known as "due diligence" and is accompanied by tax advisors, lawyers and other M&A consultants and experts.
  3. In the next step, a corresponding offer is communicated, which is discussed in subsequent negotiations between the buyer and the target company. Two important terms that are relevant in this context are the term sheet and the letter of intent. The former documents key points of the future contract without specifying details. Rather, the term sheet is intended to give the parties involved certainty and serve as an initial binding basis for a subsequent contract. In the Letter of Intent, the parties involved confirm in writing their intentions to carry out the merger or acquisition. This also serves as the basis for further negotiations.

Subsequently, the actual drafting of the contract takes place. It is considered concluded when the contract has been signed by both parties. Once this has happened, the mutual fulfillment of what is stipulated in the contract begins.

The Mergers & Acquisitions process includes various puzzle pieces, which are symbolized in this picture by four large puzzle pieces
Mergers & Acquisitons Definition: Der M&A-Prozess erfordert eine reibungslose Fusion und Kompatibilität von mindestens zwei getrennten Einheiten und vielen anderen dynamischen Teilen.

Advantages and disadvantages

The merger of companies can bring great economic advantages. This is ultimately the reason or motive for which companies decide to buy another company or to merge with another company.

In the best case, a merger or a company purchase strengthens the market position and provides an advantage over competitors. Ultimately, the merger means an accumulation of the knowledge of the companies involved, giving them a knowledge advantage over their competitors.

Although this sounds promising, it must be noted that many M&As fail. Studies even show that two thirds of all mergers and acquisitions fail.In many cases, this is due to the "human factor". Often, not enough energy is expended on the psychological-communicative level, with the result that the corporate culture is not sufficiently integrated and employees do not feel "picked up".

However, strategic errors in the transfer of the company can also be the cause of failure. It is often found that the purchase price was set too high when the hoped-for synergy effects do not materialize after the merger.