Motives for Mergers

What Are Motives For Mergers?

Motives for mergers are the intentions and inclinations that make firms come together for a merger.

A merger is an arrangement that brings two current businesses together to form a new one. There are various types, as well as various reasons why organizations merge.

The companies that agree to merge are roughly similar in size, clients, and scale of operations.  

In other words, it is the voluntary commingling of two businesses under essentially equal conditions into a single new legal entity. The five main types are conglomerate, congeneric, market extension, horizontal, and vertical mergers.

On the other hand, an acquisition occurs when one firm buys the majority or all of the shares of another company to take control of that company.

With any merger, the general perception is that the newly formed company will be better for all stakeholders than the two separate enterprises.

Buying more than half of a target company's shares and other assets gives the acquirer the authority to decide about the newly acquired assets without the other shareholders' permission.

Mergers and acquisitions (M&A) are frequently used to broaden a company's reach, enter new markets, or increase market share. All of this is done to boost the value of the company's stock.

M&A is a general word that defines the consolidation of firms or assets through several forms of financial transactions, including mergers, acquisitions, consolidations, tender offers, acquisition of property, and management acquisitions.

The primary motive for each combined entity is to increase shareholders' value and make more profits. In addition, some companies merge to make efficient use of their resources.

Similar to M&A, Consolidation is done by integrating core companies and doing away with outdated organizational structures; consolidation results in the creation of a new company. 

Shares of common ownership in the new company are distributed to shareholders of the two companies who have approved the merging of the two entities.

Understanding Motives For Mergers

As said before, its primary purpose is to increase its shareholders' value. Companies combine for various purposes, such as accessing resources, reducing operating and transporting costs, raising investments and funding, etc. 

Some primary motives are discussed below.

Value Generation

An agreement between two businesses may be made to boost shareholder wealth. Synergies that increase the value of a newly formed corporate entity are typically produced through the combination of two enterprises. 

In its simplest form, synergy is when the combined value of two enterprises is more significant than their values. Note that there are two types of synergies:

Revenue synergies: Synergies that primarily increase the company's capacity to generate revenue are known as revenue synergies. Examples of causes that can result in revenue synergies include market expansion, production diversification, and R&D efforts.

Cost synergies: Synergies that lower the cost structure of the business. 

Typically, combining two effective entities can lead to cost savings, access to new technology, and even eliminating some costs. All of these things could help a company's cost structure.

Diversification

The goal is typically diversification. For example, a corporation may use a merger to diversify its business operations by entering new markets or providing new goods or services. Additionally, it is typical for a company's managers to set out an agreement to diversify operational risk exposure.

Be aware that shareholders are not always happy with the scenario when the goal of risk diversification primarily drives the deal. 

While a merger of two businesses is often a protracted and risky process, shareholders can readily diversify their risks through investment portfolios in many situations. 

Diversification goals frequently drive conglomerate mergers, product extensions, and market expansions.

Acquisition of Assets

A desire to acquire specific assets that cannot be acquired through other means may be the driving force. 

It is extremely common in M&A transactions for some businesses to set up mergers to obtain access to special assets or assets that typically take a long time to develop internally. For instance, gaining access to new technologies is common.

Increase in Financial Property

Every business has a maximum amount it can spend on debt or stock markets to fund operations.

A business may combine with another if it lacks the necessary financial resources. A combined entity will thus achieve a bigger financial capacity to be used in subsequent business development procedures.

Tax Purposes

A business that produces a lot of taxable income may merge with a business with many carryover tax losses. However, following the merger, the combined business's overall tax obligation will be significantly lower than that of the individual company.

Incentives for Managers

Sometimes the personal objectives and interests of a company's top management serve as the primary driving force. For instance, a merged business ensures increased reputation and power, which management can see favorably.

The managers' ego and goal of becoming the largest company in the sector might also support such a drive. This process, known as "empire building," takes place when business management begins to value a company's size more than its actual performance.

Market Power

In a tiny business, a horizontal merger will undoubtedly aid in boosting market share. The ability to control prices will follow from a larger market share. 

A monopoly is an extreme case of a horizontal. However, a vertical can also improve market dominance by lowering reliance on outside suppliers.

Some Hidden Abilities

Not every business can have all the assets or competitive advantages needed for successful expansion. As a result, there will be a time when the business wishes to acquire the skills and assets it lacks.

As opposed to building the competencies domestically, this is accomplished through M&A in a very cost-effective manner.

Rapid Growth

Any corporation can expand either through organic growth or external growth. By making internal investments, organic growth is attained by an increase in revenues. 

Increasing sales and acquiring external resources through M&A means external expansion.

Companies frequently prefer to expand externally, especially those in mature industries with few chances for expansion. Having external expansion reduces risk.

Reduce redundancy and improve overall performance efficiency by utilizing each other's capabilities. Opportunities are created by the synergy that would not have been possible for businesses functioning alone.

New Goals

Companies perform well in their markets when combined to form a merger. The companies that merge set up new goals and targets after discussing them with each other. 

Companies usually merge to explore new goals and targets, such as new markets that can be entered to unique market products, technology transfer to new markets, taking advantage of market imperfections, overcoming negative government policies, ongoing assistance to clients from abroad, etc. 

Types of mergers

These are divided into three different categories based on the company's function, the industry they work in, and the product line. Therefore, these combined entities are differentiated into vertical, horizontal, and conglomerate entities discussed as follows.

Vertical Merger

A vertical combination of two firms occurs when two or more companies unite to serve different supply chain roles for the same commodity or service. The most common reasons for a merger are to increase synergies, obtain more control over the supply chain, and ramp up business.

Two businesses in the same industry, but at different points in the production/distribution, combine to function efficiently. Therefore, it is also known as vertical integration. A famous example of this is America Online and Time Warner.

Horizontal Merger

Occurs when two companies create and sell the same products, i.e., when they are competitors. Horizontal mergers, if large enough, can limit market competition and are frequently scrutinized by competition authorities.

Simply put, it is when two businesses in the same industry and at the same point combine to function more efficiently. Therefore, it is also known as horizontal integration. 

Common examples of this type are Daimler & Chrysler, RBS, and NatWest. 

Conglomerate

Combines two enterprises with no shared interests. Their industries do not intersect and are not competitors, yet, they believe there are advantages to combining their firms.

Conglomerate entities are further divided into two categories known as pure and mixed conglomerate mergers based on the similarities the companies have between them. 

Market Extension Merger

This happens between two businesses that work on the same items but in different markets.

The primary objective of the market expansion combination is to ensure that the merging companies can obtain access to a broader market, which provides a more significant client base.

Congeneric Merger

It is a particular kind of combination in which two businesses unite even if they do not share the same products or operate in the same markets or industries. 

Congeneric combinations can benefit from synergies between the companies' similar distribution networks.

How to finance A Merger?

Different ways to finance are:

1. Cash
   • The acquirer's shareholders retain the same level of influence over their business.
   • Because of its simplicity and precision, it has a better chance of succeeding.
   • Acquiring shareholders assume full responsibility for the failure of the promised synergistic value to materialize.
   • Capital gains tax may be due on cash received by target shareholders.
   • Cash offers solve the problem of "swapping" shares' valuation.
2. Shares
   • The target shareholders still have a stake in the amalgamated company.
   • There is no immediate cash outflow for the acquirer
   • Target shareholders bear the risk of failing to create synergistic value
   • The target shareholders might defer capital gains tax.
3. Loan Capital
   • Loan capital is money that has to be paid back. Loans, bonds, and preferred stock are examples of this type of finance that must be repaid to investors. 
   • Loan capital, unlike ordinary stock, necessitates some form of periodic interest payment to investors in exchange for the use of the money.

The interested parties can also opt for a combination of all of the above-mentioned financing options.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Joint Venture (JV)
• Letter of Intent (LOI)
• Memorandum of Understanding (MoU)
• Merger
• Mergers & Acquisitions (M&A)