THE BASIC FORMS OF ACQUISITIONS

THE BASIC FORMS OF ACQUISITIONS

 

There are three basic legal procedures that one firm can use to acquire another firm: (1) merger or consolidations, (2) acquisition of stock, and (3) acquisition of assets.

 

Merger or Consolidation

A merger refers to the absorption of one firm by another. The acquiring firm retains its name and its identity, and it acquires all of the assets and liabilities of the acquired firm. After a merger, the acquired firm ceases to exist as a separate business entity.

A consolidation is the same as a merger except that an entirely new firm is created. In a consolidation, both the acquiring firm and the acquired firm terminate their previous legal existence and become part of new firm. In a consolidation, the distinction between the acquiring and the acquired firm is not important. However, the rules for mergers and consolidations are basically the same. Acquisitions by merger and consolidation result in combinations of the assets and liabilities of acquired and acquiring firms.

There are some advantages and some disadvantages to using a merger to acquire a firm:

1.       A merger is legally straightforward and dose not cost as much as other form of acquisition. It avoids the necessity of transferring title of each individual asset of the acquired firm to the acquiring firm.

2.       A merger must be approved by a vote of the shareholders of each firm. Typically votes of the owners of two-thirds of the shares are required for approval. In addition, shareholders of the acquired firm have appraisal rights. This means that they can demand that their shares be purchased at a fair value by the acquiring firm. Often the acquiring firm and the dissenting shareholders of the acquired firm cannot agree on a fair value, which results in expensive legal proceedings.

 

Acquisition of Stock

A second way to acquire another firm is to purchase the firm’s voting stock in exchange for cash, shares of stock, or other securities. This may start as a private offer from management of one firm to another. At some point the offer is taken directly to the selling firm’s stockholders. This can be accomplished by use of a tender offer. A tender offeris a public offer to buy shares of a target firm. It is made by one firm directly to the shareholders of another firm. The offer is communicated to the target firm’s shareholders by public announcements such as newspaper advertisements. Sometimes a general mailing is used in a tender offer. However, a general mailing is very difficult because it requires the names and addresses of the shareholders of record, which are mot usually available.

The following are factors involved in choosing between an acquisition of stock and a merger:

1.       In an acquisition of stock, no shareholder meeting must be held and no vote is required. If the shareholders of the target firm do not like the offer, they are not required to accept it and they will not tender their shares.

2.       In an acquisition of stock, the bidding firm can deal directly with the shareholders of a target firm by using a tender offer. The target firm’s management and board of directors can be bypassed.

3.       Acquisition of stock is often unfriendly. It is used in an effort to circumvent the target firm’s management, which is usually actively resisting acquisitions. Resistance by the target firm’s management often makes the cost of acquisition by stock higher than cost of merger.

4.       Frequently a minority of shareholders will hold out in a tender offer, and thus the target firm cannot be completely absorbed.

5.       Complete absorption of one firm by another requires a merger. Many acquisitions of stock end with a formal merger later.

 

Acquisition of Assets

One firm can acquire another firm by buying all of its assets. A formal vote of the shareholders of the selling firm is required. This approach to acquisition will avoid the potential problem of having minority shareholders, which can occur in an acquisition of stock. Acquisition of assets involves transferring title to assets. The legal process of transferring assets can be costly.

 

A Classification Scheme

Financial analysts have typically classified acquisitions into three types:

1.       Horizontal Acquisition. This is an acquisition of a firm in the same industry as the acquiring firm. The firms compete with each other in their product market.

2.       Vertical Acquisition. A vertical acquisition involves firms at different steps of the production process. The acquisition by an airline company of a travel agency would be a vertical acquisition.

3.       Conglomerate Acquisition. The acquiring firm and the acquired firm are not related to each other. The acquisition of a food-products firm by a computer firm would be considered a conglomerate acquisition.

 

A Note on Takeovers

Takeover is a general and imprecise term referring to the transfer of control of a firm from one group of shareholders to another. Control may be defined as having a majority vote on the board of directors. A firm that has decided to take over another firm is usually referred to as the bidder. The bidder offers to pay cash or securities to obtain the stock or assets of another company. If the offer is accepted, the target firm will give up control over its stock or assets to the bidder in exchange for consideration (i.e., its stock, its debt, or cash)

For example, when a bidding firm acquires a target firm, the right to control the operating activities of the target firm is transferred to a newly elected board of directors of the acquiring firm. This is a takeover by acquisition.

Takeovers can occur by acquisition, proxy contests, and going-private transactions. Thus, takeovers encompass a broader set of activities than acquisitions.

If a takeover is achieved by acquisition, it will be by merger, tender offer for shares of stock, or purchase of assets. In mergers and tender offers, the acquiring firm buys the voting common stock of the acquired firm.

Takeovers can occur with proxy contests. Proxy contests occur when a group of shareholders attempts to gain controlling seats on board of directors by voting in new directors. A proxy authorizes the proxy holder to vote on all matters in a shareholders’meeting. In a proxy contest, proxies from the rest of the shareholders are solicited by an insurgent group of shareholders.

In going-private transactions, all the equity shares of a public firm are purchased by a small group of investors. The group usually includes members of incumbent management and some outside investors. The shares of the firm are delisted from stock exchanges and can no longer be purchased in the open market.