What are Vertical & Horizontal Mergers and Acquisitions?
In 2020, two telecom industry giants — Sprint and T-Mobile — merged in an all-stock deal valued at $26 Billion, making this one of the largest mergers and acquisition events in history.
M&A is an excellent strategy for companies to scale up. But what you may not know is that there’s a fine line between a merger vs. an acquisition.
Want to know the difference between a business merger and a business acquisition? Keep reading this guide to learn more.
Mergers and Acquisitions: Explained
The confusion about mergers and acquisitions is understandable. After all, companies tend to only use the term merger in press releases. “Acquisition” can have a negative connotation, so some firms don’t use it.
If you’re preparing for a merger or acquisition at your firm, here’s the distinction you need to understand.
What Is a Business Acquisition?
When a company purchases and takes over another firm, this is what’s known as an acquisition. Technically, an acquisition can be either hostile or friendly.
In a friendly acquisition, the target firm agrees to the purchase. Hostile takeovers occur when the acquired company doesn’t agree to the purchase, but the shareholders approve it anyway.
For clarity, when we say acquisition here, we mean a friendly acquisition.
In an acquisition, the acquiring company’s management team might replace the acquired firm’s leadership. There is usually no new, merged firm. Instead, the acquired organization takes on the name and the brand of the acquiring company.
Acquisitions can be expensive endeavors. The acquiring company has to buy out the whole company or a majority of the company.
What Is a Business Merger?
Mergers occur when two separate companies agree to join forces as a single new firm. These companies are usually similar in size and serve the same customer base.
In a merger, no money may be exchanged between the two entities. They’re completely voluntary on the part of the merging companies.
Typically, the management of a merged firm becomes a hybrid task force. This force is made up of leaders from the original two firms. In some cases, merged companies have co-CEOs.
When two companies undergo a friendly merger, the new, larger firm tends to take on a single name. It can be a new name or the name of one of the original companies.
Types of Mergers
Despite the overuse of the term, mergers are actually less common than acquisitions.
When a true merger does occur, it can be one of five general types. Each type of merger tends to have a different goal, which we’ll talk more about next.
A conglomerate is a group of merged companies that don’t compete for the same markets. Conglomerate mergers are usually diversification strategies. And conglomerate mergers can be pure or mixed.
Pure conglomerates are mergers between firms that don’t share much in common. The two firms probably don’t serve the same market or offer similar products.
On the outside, mixed conglomerate mergers might look similar to pure conglomerate mergers. But the owners usually see some product or market synergies between the two companies.
For example, Disney and ABC (the American Broadcasting Company) merged in 1995. This was a mixed merger.
Disney had a film studio, and ABC was a broadcasting company. The two companies served similar markets and achieved 70% revenue synergies after only 10 years.
Product Extension Mergers
Product extension mergers occur between companies that cater to the same market. However, the two firms sell different products or services.
The advantage of a product extension merger is that the companies get new products to offer their customers. Together, the merged companies can capture a larger portion of their shared market.
An example of a product extension merger was when Broadcom and Mobilink Telecom merged in 2002.
Broadcom manufactured Bluetooth systems while Mobilink supplied cellular chips. Apart, these companies served the same industry but offered different products. Together, they captured a larger share of the telecom market.
Market Extension Mergers
In comparison, market extension mergers occur between firms with the same or similar products. What the two companies don’t share in common is the same market.
Market extension mergers are excellent ways to scale into new customer bases. This could be an international market or domestic markets that are still untapped.
For example, when the Canadian bank RBC wanted to enter the US market, it merged with Eagle Bancshares. Eagle Bancshares already had a strong foothold in the state of Georgia — one of the strongest financial markets in the US.
When two or more companies merge horizontally, it’s because these firms serve the same industry or sector. Horizontal mergers often occur between two competitors.
Why would two companies consolidate? Horizontal mergers help companies in less mature spaces capture greater market share. Other reasons for consolidation are to get greater economies of scale or to increase competition.
An example of a horizontal merger was the combination of T-Mobile and Sprint in 2020. After the merger, the combined entity earned a greater market share and became more competitive.
Vertical mergers happen between companies in the same industry. Specifically, vertical mergers usually occur when two separate members of the supply chain combine forces.
For example, it would be a vertical merger if an auto parts supplier merged with the company that assembles those parts.
Companies usually undergo vertical mergers to help cut costs. Vertical mergers are also smart strategies for manufacturers to get more control over raw material production and quality.
Reasons Companies Merge
By now, you may wonder: why would two companies want to merge in the first place? We’ve already touched on a few reasons, including creating cost or revenue synergies, capturing more of the market, or expanding into new markets.
But those aren’t the only reasons companies merge. Here are three additional factors that influence the decision to combine forces with another firm.
To Harness Tax Benefits
It’s common for married people to file jointly if one spouse makes significantly less income than the other. Why? Because this strategy can reduce the household’s overall taxable income.
Businesses sometimes use this strategy, too. Large companies have huge tax liabilities. But if the firm merges with a smaller company investing in R&D for new products and has tax losses, the combined entity’s total taxable income can drop significantly.
To Improve Financial Capacity
Financial capacity refers to an organization’s ability to use debt financing or equity. When a company’s financial capacity hits its ceiling, it can merge with another firm. Together, the new entity will have an increased financial capacity.
To Gain More Prestige
Businesses are run by people, and people have egos. So, it should be no surprise that mergers sometimes happen because the management team wants more power or notoriety. This is sometimes called empire-building. Unfortunately, this motive for mergers is often selfish. There’s evidence that a firm’s size directly correlates with its management team’s compensation.
Types of Acquisitions
Just like there are different types of mergers, there are various forms an acquisition can take. The various kinds of acquisitions are usually defined by what the acquirer is actually paying for.
Acquiring firms can purchase the target company’s stock or assets.
In a stock purchase acquisition, the acquiring company pays for the target firm’s shares. With a cash offer, the acquirer pays the amount for a majority stake in the acquired company’s shares.
Stock offerings are different. The acquiring firm issues new shares in its own stock to the target company in exchange for a controlling interest. The acquirer then assumes all assets and liabilities of the acquired company.
The one downside to stock purchases is the timeline. All shareholders must approve stock purchases, which can be a lengthy process. Also, the buyer’s attorneys may prefer asset purchases to minimize liabilities.
Acquirers can also purchase a company’s assets outright in an acquisition. This allows acquiring companies to gain a firm’s assets without incurring its liabilities.
The acquiring company can either pay the target firm in cash or stock. Since only the assets are purchased, the acquirer doesn’t need approval from the target firm’s shareholders. This speeds up the process.
However, there is a disadvantage to asset purchases. Because the acquiring company pays in cash, the target firm will have to pay a capital gains tax on the money received in the purchase.
Reasons Companies Acquire
The most obvious reason for an acquisition is to create synergies. In general, there are two types of synergies merging companies go after. These are revenue and cost synergies.
Revenue synergies occur when two companies can make more money together than each could separately. Cost synergies are similar. Cost synergies occur when two companies can save more working together.
Here are some other reasons companies acquire.
To Scale Up
Organic growth is a lot of work. So, what can a company do when it wants to scale its revenues a lot and quickly? An acquisition is a relatively quick and cheap way to expand revenue streams and/or the customer base.
To Go International
Entering new markets offers opportunities for customer base growth and higher revenues. But going international is easier said than done. That’s why many firms choose to enter a new market through acquisition. Our firm has handled the sale of US-Based companies to foreign companies that want to get a foothold into the US market.
Acquired foreign businesses are more established than the parent company. The acquired firm speaks the local language, has relationships with suppliers, and is reputed in the market. This can help the parent company get its foot in the door more easily.
To Eliminate Competition
If you can’t beat them, join them. This age-old phrase is the theory behind acquisitions done to reduce competition. Acquirers will scoop up smaller firms and make them redundant or absorb their capabilities.
An added benefit of eliminating competition is removing excess capacity in the market. Acquiring competition restricts supply. And when supply drops below demand, prices go up.
To Acquire New Technology
When a new capability emerges on the market, companies have two options: either scramble to build out the product organically or play it cool and acquire a company that already has that product.
This strategy may cost companies upfront. But it greatly reduces the long-term costs of paying engineers and quality testing analysts for a build-out. It’s also much faster to acquire new tech than to develop it from scratch.
3 Ways Companies Integrate After M&A
After a merger or acquisition occurs, the next step is integrating the two companies into a new entity.
Here are the three ways companies integrate after an M&A event.
1. Statutory Integrations
Statutory integrations are almost always acquisitions.
In a statutory integration, the acquiring company is much larger than the firm it’s buying. The acquirer purchases all of the acquired company’s assets and liabilities. In exchange, the acquirer absorbs the target company.
Subsidiary integrations are also usually acquisitions.
Sometimes, acquirers decide to allow the target company to continue operating as normal. The acquired company retains its employees, management team, and name.
The only thing that changes is that the target company is now a subsidiary of the parent company (the acquirer).
Consolidations are almost always mergers.
In a consolidation merger, two companies combine powers. They then take on a new name and management team to reflect the consolidation.
The new name could be a combination of the merged companies’ names or something completely new.
Mergers and Acquisition Firms Can Help Your Business
Mergers and acquisitions are two ways for two companies to join forces. Mergers happen when two companies agree to become one powerful entity. Acquisitions occur when one company purchases another with stock or cash.
Are you preparing to sell your business to an acquirer? We’re here to help. Register with us for free today and find out how much your business is worth! We have many years of experience helping companies with mergers and acquisitions in Healthcare, Technology, Manufacturing, Construction, Distribution, and Services.
If you are interested in acquiring a company, please view our Businesses for sale and fill out our electronic NDA on a business of interest.
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