What is a merge and how does it work?

A merger is a mutual agreement between companies to join in a new business that creates shareholder value. Discover the different types, pros and cons.

A corporate merger is when two or more companies combine to form a new company. They are usually large-scale and mutually beneficial deals. The goal behind each merger is to create a new corporate entity that is stronger than the original individual corporations.

What is a merger?

In general, the companies involved in a merger agreement are relatively the same size. Each has its unique value that benefits the other companies involved in the deal. The idea is that by combining forces, companies can achieve long-term superior performance as a single company.

For example, one company may have an award-winning product but no distribution network, while another company may have a global logistics infrastructure but declining demand for its own products. Both companies can benefit from each other, and an initial partnership can develop into something more permanent, such as a corporate merger.

Of course, there are many other reasons why companies, sometimes even rivals, will join forces.

• Enter foreign markets – Penetrating international markets can be challenging. Beyond the cost of exporting or moving production, a lack of understanding of the local culture can make success very difficult. A merger with a company that already has a foothold in a target market could dramatically lower barriers to entry.
• Access new growth – A larger entity can benefit from economies of scale, paving the way for cost reduction and higher margins.
• decrease competition – With mergers, companies grow in size. And with more resources available, the newly formed company is often better able to handle the competition. These agreements also help similar companies avoid product duplication within a market.
• Get new technology/resources – Some companies have access to proprietary resources, such as patents or regulatory licences, that are nearly impossible to replicate. Through a merger, companies can tap into these potentially lucrative resources to establish market dominance.
• Avoid bankruptcy – Mergers can keep struggling companies from going under, protect jobs and breathe new life into a business with long-term potential.

Acquisition vs Acquisition vs Purchase vs Merger

Acquisition, Acquisition, Buyout, and Merger all have one thing in common. In each scenario, two or more companies combine to form one. However, even though the terms are often used interchangeably, they have some contrasting differences. And not all of them are nice.

• Fusion – A mutual union of two or more companies into a new corporation.
• Acquisition – An acquisition is a friendly acquisition between two companies that benefits all parties. The acquiring company, individual, or asset management fund approaches the target company’s board of directors with a public offer to acquire the company in its entirety. If the board, shareholders and regulators agree to the deal, the acquisition is executed and ownership of the business changes hands.
• Take the control – Sometimes acquisition offers are not welcome. But if the prospective buyer is persistent, a takeover can occur. This is when the board of directors is completely bypassed and the acquirer goes directly to the shareholders with an offer.
• Buys – A purchase is similar to an acquisition. It is often executed by buying or controlling the majority capital of the company.

types of mergers

While the desired end result of a merger is always the same, several different types can occur.

• Vertical Fusion – A vertical merger is the union of companies that operate in the same industry but at different levels in the supply chain. These deals are often pursued to create synergy in pursuit of greater operational efficiencies.
• Horizontal Fusion – A horizontal merger occurs between companies in the same sector. These companies are often direct competitors who agree to combine to achieve economies of scale.
• Conglomerate Fusion – A conglomerate merger is the combination of two companies operating in different industries without overlap. This type of merger deal is quite rare and can usually only be executed if it directly increases shareholder wealth.
• congeneric Fusion – In a congeneric merger, companies from the same industry but involved in totally independent operations or services join together. This allows new products to be brought to market quickly, access a broader pool of potential customers and secure new market share.
• Market Extension Fusion – This is the combination of two businesses that sell similar products in different geographic markets. The companies combine to access new markets respectively and expand their customer base.
• SPAC Fusion – A special purpose acquisition company will typically execute a reverse merger with a private company. This is often a cheaper method for a private company to go public compared to the traditional route of an initial public offering (IPO).

Disadvantages of a Corporate Merger

While a merger undoubtedly brings many benefits to the table, it is not without its drawbacks. Some of the significant disadvantages of these offers are:

• Integration costs – Combining two businesses can be an expensive process with complications unforeseen when the deal is originally signed. Some common problems include:
  • Corporate Culture Differences – When two companies come together, it also means that two corporate cultures combine to form one. Contrasting mindsets and approaches can lead to tension among employees that can harm productivity and create internal conflict.
  • job layoffs – With mergers, many jobs, especially in administration, become redundant, ultimately leading to unemployment.
  • Resignation of Key Personnel – Not all employees may be happy with the deal. And some workers often choose to separate, which can lead to the loss of valuable talent. Acquiring and training replacement staff can be extremely expensive.
• raise the prices – With reduced market competition, mergers can increase product prices, making things more expensive for customers.
• No guarantee of value creation – A merger aims to form a new company that can create shareholder value. However, unforeseen complications and excessive expectations can cause value to be destroyed rather than created, making the situation worse for shareholders.

The bottom line

A successful merger is a unanimous agreement between companies to combine their businesses to create better shareholder value. There are many types of mergers according to the variety of businesses in operation. While some investors favor mergers due to their huge benefits, others steer clear of such companies due to their potential drawbacks.

Nonetheless, mergers are a popular way to merge companies to create larger, more sustainable companies.

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This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment depends on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor should consider his or her individual financial circumstances and contact an independent financial adviser if necessary.