An acquisition is most commonly defined as a corporate action in which a company acquires entirely or partially another firm’s ownership stake. The degree of control acquired by the buying entity as a result of this transfer of shares usually reflects the percentage of shareholding that changes hands as a result of the transaction.

An acquisition of shares can be paid for in various ways: simply by means of a cash payment which would reflect the monetary value of the shares acquired or by paying the owners of the company whose shares have been acquired an equivalent value in the form of shares of the acquiring company.

A combination of these two methods is also possible. The corporate action itself may appear to be straightforward in theory, but in practice the issues that could arise are usually pretty complex. So what are the reasons for such acquisitions taking place?

It is pretty clear, particularly during the ‘growth stage’ of a company, that there are several reasons why a company could be interested in making an acquisition. One would be to acquire a competing company, thereby increasing market share and decreasing competition in one swoop. This is potentially a quicker and safer way of increasing market share rather than going through the lengthy process of expanding marketing and sales efforts. What you essentially have is instant market penetration as well as a list of new clients readily available.

A number of companies also make acquisitions of what might be regarded as ‘complimentary’ companies which, while not working in exactly the same sector as the acquiring entity, may, however, still provide a number of synergies to the acquiring company. These synergies are important, as they provide a huge amount of flexibility to the acquiring company particularly in terms of economies of scale and pricing power, while also combining the different strengths of the companies.

Diversification is one of the most important ‘spin-off’ effects

These synergies can actually go further; debt capacity can increase, the combined value of the companies may actually exceed the value of each company on its own. There may also be other benefits based on company size such as the reduction of overall costs and overhead percentages. Such an acquisition may also lead to a higher degree of diversification which in turn leads to a reduction of risk.

Diversification is, in fact, one of the most important ‘spin-off’ effects of an acquisition. A number of companies feel it would make good sense to invest into other sectors, possibly complimentary, which would allow them to spread the risks involved with the running of the business and, at the same time, allowing them some degree of manoeuvring even when their core business is not passing through the best of times. One can also look at this from the shareholders’ viewpoint, putting it in the same perspective of the average investor wanting to spread his risk by diversifying his investment portfolio.

An opportunity might arise where an owner needs to sell off quickly, with his company being available for acquisition at a fraction of its value. Myriad reasons may compel someone to sell a company quickly, from sickness to succession issues. Therefore, it is of great importance for companies to always have an ear tuned to the market to ensure that should such an opportunity arise they will be in time to make an offer.

An interesting observation at this point is that it may be easier to debt finance such an acquisition rather than to receive debt finance to cover what could be termed as traditional internal growth. Banks, which tend to be rather conservative, may not be too quick to accept the growth rate one is expecting to achieve as a result of new practices or bringing new people in. They, however, cannot deny the numbers, black on white, of an actual running concern. One can almost say that bankers actually prefer financing growth by acquisition.

Companies may, of course, be acquired for much less complex reasons. Technology and business practices are notoriously difficult and expensive to develop, talented employees and managers are difficult to come by and the immediate addition of distribution channels that are generally difficult, costly and time-consuming to otherwise create are valid and nearly obvious reasons why an acquisition can mean so much to a company and its future.

Before making an acquisition it’s important for a company to make an evaluation of its target, to see if it would be a right fit, if the asking price is reasonable, whether there are any pending lawsuits, if the company has any creditors or debtors, number of employees, client base, whether all financials are in order and whether the company structure would allow for a smooth takeover.

This is where the services of a corporate broker can help a company looking to make an acquisition.

Alain Guillaumier is a management consultant at Baviere – Corporate Brokerage.