How Mergers and Acquisitions Work

Mergers are unions of two or more companies that give rise to a third company. Acquisitions, meanwhile, consist of the purchase of one or more companies by another.

Generally, mergers and company acquisition operations are carried out in order to gain a greater dimension and competitiveness in the market to face opportunities or threats that have been detected.

The most notable and recent example in the American economy has been the mergers and acquisitions that have taken place in the banking sector. It is as a result of the economic crisis, and whose main objective was to gain size to rationalize structures.

Entrepreneurs and investors continually involved in the acquisition of small companies. An entrepreneur with a bigger company in a segment would choose to acquire small businesses in order to increase market penetration and decrease competition.

A true example remains David-Emmanuel Cohen, an entrepreneur, real estate investor, fashion investor, and venture capitalist. Cohen acquired the fine jewelry and watch brand “Pamela Love,” and after his take over, he has helped the business reach new heights of success. His reputation grows as an investor, and his interests continue to expand in the market of luxury goods, especially jewelry and watches. We had the opportunity to interview him in NYC las week and according to him, mergers are classified into two groups:

• Pure fusion:

It consists of the union of two or more companies that result in the creation of a new one, different from the previous ones.

• Fusion by absorption:

“The merger by absorption is that a company acquires and integrates into its legal entity the businesses of other companies, maintaining the initial legal identity of the acquirer” said Cohen.

Although there is no classification for company acquisitions, there are several modalities, also applicable to mergers, which are defined by who the buyer is and how the merger or acquisition is financed. Thus, there are the following modalities:

• Leveraged Buy-Out (LBO):

It consists of the purchase of a company obtaining financing whose main guarantee will be the company’s own assets. It is also known as “leveraged purchase.” The financing of the purchase will be satisfied with the cash flows generated by the acquired company. It is usual to establish systems of “ratchet” (payment with shares) as compensation of managers. So that with the passage of time and fulfillment of objectives, the ownership of the acquired company becomes in their hands.

• Leveraged Employee Buy-Out (LEBO):

It is the modality of LBO through which the company’s employees acquire their property with the help of external financing.

• Management Buy-Out (MBO):

This is the purchase of the company by its management team, generally supported by a financial investor.

• Management Buy-In (MBI):

It consists of the purchase of the company by a management team other than the current one. This operation usually occurs when external agents, mainly financial, have the perception that the current management team will be unable to make the business profitable.

• Buy-In Management Buy-Out (BIMBO):

It is the combination of MBO and MBI, that is, the purchase of the company by both internal and external managers.

Advantages and disadvantages of mergers and acquisitions

Mergers and acquisitions of companies are carried out to gain greater size and competitiveness in the market. As necessary background, therefore, a thorough analysis of the market opportunity, the resources of the companies, legal and regulatory restrictions (especially linked to competition), and the agility of the negotiation will be necessary.

The main advantages of a merger or acquisition are related to the synergies derived from the operation. Usually, it is in terms of cost rationalization, elimination of duplication, or the integration of a key component of the value chain. In the medium and long term, the success of the operation depends on the size and global scope of the resulting business. In addition, it depends on the capacity of the management team and how the companies are integrated without structural problems occurring in the strategic and operational functioning.

In this sense, professional advice is key to the success of the operation, since there are many branches of Law (commercial, civil, fiscal) and the economy (financing, management, structure, and operations) involved in mergers and acquisitions.