What is M&A?

Mergers & acquisitions (M&A) refer to the management, financing, and strategy involved with buying, selling, and combining companies.

The M&A Process: How Mergers and Acquisitions Work

A merger or an acquisition usually starts out with a series of informal discussions between the boards of the companies, followed by formal negotiation, a letter of intent, due diligence, a purchase or merger agreement, and finally, the execution of the deal and the transfer of payment.

Quite often, these transactions can take six to nine months (smaller deals often take less time and larger deals often take more time), and they can be complex, particularly from legal and accounting perspectives. For these reasons, companies often hire investment bankers or other intermediaries to facilitate M&A transactions.

These intermediaries can help sellers find buyers (or vice versa), conduct the negotiations for a client, handle paperwork, and perform the due diligence on the other party. For this, the intermediary receives a fee, which is usually a percentage of the transaction amount.

[Check out some Tips on How to Analyze an Acquisition Announcement]

Why M&A? Why do Companies Buy Other Companies?

The key idea behind M&A is the creation of synergy. When two companies join in an optimal fashion, the resulting entity may have better economies of scale, better use of resources, and a more effective market presence, all of which potentially lead to more profit and sustainable competitive advantage.Thus, for many CEOs, navigating a successful merger or acquisition can be a crown jewel professionally.

A company may acquire another company for a number of reasons. Let's go through a few common reasons why a company may acquire or merge with another company:

1. Geographic expansion. For example, if 'Bank of the East' is prolific in one geographic region but wants to expand its reach into another, it may purchase another bank (perhaps 'Bank of the West' or 'Bank of the North') with strong roots in another region to quickly expand its geographic footprint. Not only does an acquisition like this let 'Bank of the East' avoid having to painstakingly buy land and build new branches on its own, it also saves it from having to hire new employees, build vendor relationships, and even establish its brand in the new region if it decided to keep the 'Bank of the West' brand.

2. Product-line or business-line expansion. A company may acquire or merge with another company to diversify its revenue by expanding the number of product types it offers or getting into a new line of business altogether. For example, a soft-drink maker could buy a company that specializes in making juice to expand its offerings. Or a computer manufacturer could purchase a television manufacturer to expand into a new line of business.

3. Technology or skill expansion. If a company has patented technology or highly skilled workers, a competitor may find it faster and easier to acquire or merge with that company rather than recreate the technology or train less-experienced workers.

4. Brand power. In all cases of acquisition, a company may acquire or merge with another company to obtain a valuable brand and reap the benefits of that brand as its own. When Disney acquired the Marvel brand, for example, it was able to use combine its movie-making talent with the valuable comic-book brand to create a multi-billion dollar lineup of superhero movies it wouldn't be able to create on its own.

5. Acquisitions are its business. Holding companies, hedge funds, private equity firms, and business development companies (BDCs) regularly acquire or buy large percentages of companies as an investment to grow. Icahn Enterprises, for example, is a 'conglomerate holding company' that has bought everything from airline and steel companies to pharmaceuticals and casinos. These companies often get a big say in how the acquired companies are run, even earning seats on the executive board.

It's important to note that not every M&A is successful, and quite often they fail. If managers lack foresight, take their eye off the ball (by failing to tend to the day-to-day business while working on a merger or acquisition), or cannot overcome challenges that a deal will present, mergers and acquisitions can prove to be expensive mistakes.

[For investors, knowing how to analyze mergers & acquisitions can give them a greater chance to profit from price fluctuations that happen after the event. See How to Play the Buyout Game: 3 Tips for Finding the Best Deals to learn more.]

What's the Difference Between a Merger and an Acquisition?

A merger is the combination of two similarly sized companies combined to form a new company, such as Exxon Mobil or BBVA Compass.

An acquisition occurs when one company clearly purchases another and becomes the new owner. This was the case with Amazon's acquisition of Whole Foods, Google buying Motorola, or CVS purchasing Aetna.