The most common reasons for M&A deals Show
What are the Different Motives for Mergers?Companies pursue mergers and acquisitions for several reasons. The most common motives for mergers include the following: 1. Value creationTwo companies may undertake a merger to increase the wealth of their shareholders. Generally, the consolidation of two businesses results in synergies that increase the value of a newly created business entity. Essentially, synergy means that the value of a merged company exceeds the sum of the values of two individual companies. Note that there are two types of synergies:
2. DiversificationMergers are frequently undertaken for diversification reasons. For example, a company may use a merger to diversify its business operations by entering into new markets or offering new products or services. Additionally, it is common that the managers of a company may arrange a merger deal to diversify risks relating to the company’s operations. Note that shareholders are not always content with situations when the merger deal is primarily motivated by the objective of risk diversification. In many cases, the shareholders can easily diversify their risks through investment portfolios while a merger of two companies is typically a long and risky transaction. Market-extension, product-extension, and conglomerate mergers are typically motivated by diversification objectives. 3. Acquisition of assetsA merger can be motivated by a desire to acquire certain assets that cannot be obtained using other methods. In M&A transactions, it is quite common that some companies arrange mergers to gain access to assets that are unique or to assets that usually take a long time to develop internally. For example, access to new technologies is a frequent objective in many mergers. 4. Increase in financial capacityEvery company faces a maximum financial capacity to finance its operations through either debt or equity markets. Lacking adequate financial capacity, a company may merge with another. As a result, a consolidated entity will secure a higher financial capacity that can be employed in further business development processes. 5. Tax purposesIf a company generates significant taxable income, it can merge with a company with substantial carry forward tax losses. After the merger, the total tax liability of the consolidated company will be much lower than the tax liability of the independent company. 6. Incentives for managersSometimes, mergers are primarily motivated by the personal interests and goals of the top management of a company. For example, a company created as a result of a merger guarantees more power and prestige that can be viewed favorably by managers. Such a motive can also be reinforced by the managers’ ego, as well as their intention to build the biggest company in the industry in terms of size. Such a phenomenon can be referred to as “empire building,” which happens when the managers of a company start favoring the size of a company more than its actual performance. Additionally, managers may prefer mergers because empirical evidence suggests that the size of a company and the compensation of managers are correlated. Although modern compensation packages consist of a base salary, performance bonuses, stocks, and options, the base salary still represents the largest portion of the package. Note that the bigger companies can afford to offer higher salaries and bonuses to their managers. What is a Merger?A merger is referred to as a financial transaction in which two companies join each other and continue operations as one legal entity. Generally, mergers can be divided into five different categories:
Note that the type of merger selected by a company primarily depends on the motives and objectives of the companies participating in a deal. Related ReadingsThank you for reading CFI’s guide to Motives for Mergers. To keep learning and advancing your career, the following CFI resources will be helpful:
What are the major advantages and disadvantages of diversification?Advantages and Disadvantages of Portfolio Diversification. What is an advantage of diversification by acquisition of an existing business?However, diversifying by acquiring a company in a related product market can enable a company to reduce its technological, production, or marketing risks. If these reduced business risks can be translated into a less variable income stream for the company, value is created.
What is a diversification acquisition?Diversification acquisition is a corporate action whereby a company takes a controlling interest in another company to expand its product and service offerings. One way to determine if a takeover comes under diversification acquisition is to look at the two companies Standard Industrial Classification (SIC) codes.
What are the disadvantages of diversification in a business?Increased Sales and Revenue
But at the same time, the disadvantages of diversification include startup costs and the added overhead that will be required to achieve increased sales goals. Entering a new market may be cost prohibitive, CFI cautions.
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