What Is an Acquisition?

Acquisitions Explained

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An acquisition occurs when one company takes control of, or acquires, another existing company. Normally, an acquisition occurs when a larger company buys a smaller company, although that isn’t always the case. Small companies can acquire larger companies, too.

While there are technical differences between mergers and acquisitions, the two are closely related and often discussed together as “M&A,” and the two words are often commonly treated as synonyms. In this article we will look at what an acquisition is, types of acquisitions, and how they are carried out.

Definition and Examples of Acquisitions

An acquisition occurs when one company purchases and takes over the operations and assets of another.

The company that purchases another is called the acquiring company, and the company that is bought is the acquired, or target, company.

One example of this is when Amazon acquired Whole Foods in 2017 for approximately $13.7 billion.   

How Acquisitions Work

Acquisitions can be the amicable result of friendly discussions between two firms in which the target company welcomes the acquisition. In this situation, the two companies negotiate the terms of the acquisition and ultimately reach an agreement.

However, acquisitions can also occur against the will of the acquired firm’s management in what is called a “hostile takeover.” In a hostile takeover, an outside firm acquires a controlling interest in the target firm by purchasing more than 50% of the target company’s shares. This is done by offering the existing shareholders a higher price for their shares than what they could currently get on the open market, thereby enticing them to sell.

Regardless of whether the acquisition is friendly or hostile, the shares of the acquired firm are normally bought for more than their current market value. The difference between the current market price of a share and the price offered through a takeover is called the “premium.” When Amazon acquired Whole Foods in 2017, it offered $42 per share for Whole Foods, a 27% premium over its current share price.

Types of Acquisitions

An acquisition can be paid for in cash, through a security payment such as a stock-for-stock exchange, a leveraged buyout, or a combination of several of these methods.

A company can acquire another by giving cash to the existing shareholders of the target company for their shares. This is the simplest form of payment.

In a security payment, the acquiring company will offer new securities in exchange for the securities and assets of the target company.

In a leveraged buyout, the purchasing company borrows a significant amount of the money to complete the transaction, often selling off some of the purchased assets to repay the debt once the deal is complete.

Acquisitions vs. Mergers

The words “acquisition” and “merger” are often used interchangeably in practice, but the two are technically distinct. In an acquisition, the target company is folded into the acquiring company and ceases to exist. In a merger, two firms combine to form a new company.

Merger    Acquisition
Two companies form a larger one One company takes over another
By agreement By agreement or hostile

Pros and Cons of Acquisitions

Acquisitions are motivated by a desire of the acquiring company to improve financial performance. However, as with any business activity, an acquisition is not without risk. There is no guarantee that an acquisition or merger will improve a company’s bottom line.

Pros
Cons
  • Major changes may cause integration issues

  • Ability to reduce costs through synergy may be overestimated

  • The acquiring firm may pay too much

Pros Explained

  • Economies of scale: Larger companies can buy material in bulk to streamline expenses as well as increase efficiency through specialization.
  • Increased market share: If an acquisition combines two companies in the same industry, then the new company gains the combination of each firm’s market share.
  • Vertical integration: Vertical integration occurs when a business buys another in its own supply chain.
  • Synergy: When two firms merge, they can often reduce overhead by eliminating redundant functions. This expense reduction directly improves profitability.

Cons Explained

  • Integration issues: If the cultural or operational climate isn’t compatible between the two firms, there may be problems integrating the two.
  • Overestimating synergies: It takes time to combine two companies and integrate them into one cohesive firm. A transition time must occur before synergies are fully realized.
  • Paying too much: The selling firm and its shareholders will naturally want the highest price they can get, and other parties involved in the transaction may be willing to pay more just to get the deal completed.

Key Takeaways

  • Acquisitions occur when one company buys another.
  • Acquisitions either can be mutually agreed upon by the acquired and acquiring firm, or completed through a hostile takeover.
  • There are many similarities between acquisitions and mergers, and they are often thought of as synonymous, but they are different.
  • Cash, securities offerings, or leveraged buyouts can finance acquisitions.