Types of mergers and acquisitions

Mergers and acquisitions, often referred to as “mergers and acquisitions” or M&A for short, is a general term used to describe the integration of business ownership. Integration can be achieved through various types of financial transactions, such as the pooling of capital into one entity, the purchase of a majority ownership interest in another entity, the purchase of assets of an entity, or the effective takeover of the management of an entity.

The terms mergers and acquisitions are often used together but nevertheless have slightly different meanings.

When the acquirer (the company buying another company) takes over the target (the company being acquired) and establishes itself as the new owner, this is called an acquisition. In order for a transaction to be classified as an acquisition, the acquired ownership interest must reach a certain threshold which gives the acquirer a controlling interest in voting power. Typically, such a threshold is set at one-third or one-quarter of the ownership interest in the target.

On the other hand, the term merger describes the integration of two companies, usually of a similar size, which combine their strengths and emerge on the market as a single (new) entity. In Slovenia, the merger of two companies takes place by way of an acquisition or amalgamation. Mergers are transactions where all the assets and liabilities of the target are transferred to the acquirer, which ceases to exist after the transaction. Mergers, on the other hand, involve the formation of a new company to which all the assets of the targets are transferred, and the latter cease to exist after the transfer.

In both cases, the original owners of the target companies are compensated either by a share in either the existing or in the newly created successor company. In the above case, the merger is a so-called ‘equity merger’, where the acquirer does not offer any money for the target. Alternatively, the original owners may be offered a cash consideration (in Slovenia limited to one tenth of the value of the newly issued capital) in addition to the shares in the new entity.

Types of mergers and acquisitions

Horizontal mergers

These are cases where companies in the same sector merge and compete with each other at least partially, but often not entirely. The rationale for the merger is to exploit economies of scale, usually in the areas of production, procurement, marketing or market share. The synergies of such mergers can affect all functions in the company, from research and development, support functions, human resources and even the functioning of the management. In the case of a merger of larger companies, there is a risk that the transaction will not materialise, as it will be subject to the decision or approval of the relevant competition regulatory authorities.

Vertical mergers

These are transactions involving companies linked in a supply value chain, within the same sector or from different sectors. The merger occurs between two direct links in the value chains or in a less obvious indirect link. Typically, one company is already working with another, either as a supplier, as a buyer or as a producer. The rationale for the transaction arises from the possibility of product diversification and economies of scale, improving market position by providing know-how, access to distribution channels, market information, exclusive production or even preventing other competitors from operating on favourable terms.

In Slovenia, such mergers were relatively rare between 1990 and 2010. Instead, companies have been more active in forming strategic partnerships. Vertical integration has also been less important due to information and technical advances that have enabled new innovative business models.

Concentric mergers

These are transactions where companies are linked by core technology, markets or processes. Mergers occur in order for companies to jointly develop a market for mutual benefit, to develop a needed technology or to offer a new range of product differentiation. A concentric merger or acquisition may also be motivated by the intention to reduce costs and the new revenues that may be generated by such a combination.

Conglomerate mergers

These are transactions involving companies that are not present in the same sector and are not technologically related. The rationale for mergers is risk reduction, as investing in a new sector diversifies cash flows and makes returns more stable. In this way, the cost of capital for the acquirer is generally reduced and the value of the conglomerate is increased. On the other hand, there are also synergies from the unification of management, support functions at group level and often a stronger financial position. Given the lack of knowledge in new areas, conglomerate mergers/acquisitions also raise the question of efficiency. The latter could be higher in the case of horizontal, vertical or even concentric mergers. Conglomerates are a legal entity for diversifying risks and are particularly suitable for individuals or family owners where almost all the family assets are tied up and need to be diversified.

Based on: LEP, T. (2020). The Value of Advisors to Business Owners in the Process of Selling an Equity Stake. Ljubljana: University of Ljubljana: Faculty of Economics.