Merger and Acqusitions:

Definition, Strategies & Stakes

The general public are fairly well aware of mergers and acquisitions (also known as ‘fusac’ or ‘M&A’), as operations involving large groups are regularly highlighted in the media. These are, however, complex and require the involvement of experts. The purpose of this guide will be to discuss the different forms of mergers and acquisitions, the strategies behind them, as well as the stages in their implementation.

Published on 05.04.2022

A merger and acquisition transaction : what is it?
The objective of this strategic action?
The different strategies underlying of Merger and Acquisition (M&A) transactions?
The degrees of integration of companies after a merger and acquisition operation?
the steps in the merger and acquisition process?
Leveraged M&A transactions
The joint venture: Another form of corporate matchmaking

A merger and acquisition transaction
What is it ?

The concept of merger and acquisition covers a number of different situations. In all cases, it corresponds to the merger of at least two companies with converging interests. The purpose is to allow one company to take control of another.

There are many ways to achieve this.

For example, merger and acquisition transactions may or may not result in the pooling of assets and liabilities within a single entity as permitted by the merger and acquisition mechanism. This is not necessarily the case following an acquisition where the two companies, the acquiring and the acquired, may continue to exist separately beyond the new capital link between them.

Another example: While the transaction is most often carried out by mutual agreement for companies in good standing, for companies in difficulty it takes place in the context of legal proceedings through a judicial administrator and depends on a decision by the Commercial Court.

The objective
of this strategic action?

This type of operation is carried out to expand or diversify the activity of the acquiring company. In other words, it allows a company to grow by increasing its presence in a market or its value chain.

External growth is a powerful tool for accelerating the development of companies compared to growth through internal development (also called organic growth). It is therefore favoured by companies seeking to increase their market position rapidly :

by establishing themselves in a new geographical area,
by adding to their product or service offering,
or by expanding upstream or downstream of their value chain.

In the best cases, external growth can have a multiplier effect by creating synergies – the whole may be more than the sum of its parts. For example, it will allow the company to increase its size and thus its visibility and negotiating power. Moreover, merger and acquisition operations can also generate a reduction in costs, by pooling production resources.

The specific case of the takeover of a company in difficulty

The business takeover project will not take the same form depending on whether the company is solvent or in difficulty. This type of buyout can only be done when the company is declared insolvent. If the procedure does not result in a continuity plan, the judicial administrator will coordinate the search for a buyer within the framework of a plan to sell the company. The acquisition candidate sends their offer to the Commercial Court through the intermediary of the judicial administrator. This is a standardised and generally very quick procedure that requires the support of a consultant.

the different strategies underlying
of Merger and Acquisition (M&A) transactions?

There are three types of external growth strategies:

Horizontal growth,
Vertical growth,
Conglomerate growth.

Horizontal growth consists of acquiring players present in the same market segment.

This strategy aims to strengthen the market position of the acquiring company. It allows it to increase its critical mass (in some cases, its visibility and its bargaining power with its customers and suppliers). It can allow the company enter new geographical markets, to widen the customer portfolio, to access new technologies, new processes and expertise, to rationalise the costs of distribution or supply chains, etc.

Vertical growth is the strategy of bringing together companies upstream or downstream of the production process. The value of this type of strategy is to allow the acquiring company to have greater control over certain stages of product and service supply or distribution, in order to extend its control over the value chain.

Finally conglomerate growth differs from horizontal and vertical integration in that it involves the acquirer diversifying its activity with takeovers of companies whose activity is not directly related to that of the acquiring company. The group is then made up of companies from different sectors, possibly in different countries, which makes it possible to dilute risks, particularly financial risks: Certain profitable companies may offset the losses of other entities within the same group. It may also allow a company to move from an ageing traditional sector to new, more profitable sectors.

The degrees of integration of companies
after a merger and acquisition operation?

Mergers and acquisitions cover a range of operations. Sometimes companies retain a large degree of independence, sometimes the integration and homogenisation of processes can be more extensive. For example, in the case of simple acquisition, the acquiring and the acquired companies can continue to exist separately. The two companies remain separate legal entities and each is able to keep its name.

Another case: in the case of a partial transfer of assets: a company transfers only a part of its assets, corresponding to one or several branches of activity. However, this transaction does not result in the dissolution of the contributing company.

However for an absorption through merger, where the absorbed company transfers its assets to the absorbing company, the latter continues its operations while the former ceases to exist.

The steps
in the merger and acquisition process?

We distinguish several main steps in a merger and acquisition process before the integration phase.

#1 Strategic diagnosis 🧠

Upstream of any transaction the strategic diagnosis stage is used to determine the merits of the operation. It allows us to judge the advantages of the acquisition project in relation to the constraints it presents. The analysis focuses on both the company’s intrinsic strengths and weaknesses and the threats and opportunities in the market.

#2 Identification of the target 🎯

After this diagnostic phase, the acquisition candidate has to detect a target company. A specialised firm can be mandated to conduct the search. Following exchanges of anonymized information with the seller’s advisers, the potential buyer may sign a confidentiality agreement, granting access to a detailed presentation (information memorandum) of the company being sold.

#3 Analysis of the information memorandum 🔍

Analysis of the information memorandum aims identify the determining factors of the company’s economic and financial performance over the long term, to understand its market, its positioning, its organisation, its production and human resources, etc. If this step confirms the buyer’s interest in the target company, it is quickly followed by a meeting with the seller and a visit to the target company’s premises.

#4 The valuation of the company 🏭

The valuation of the company to be bought is an essential step in determining the sale price after negotiation. This is a delicate exercise insofar as it is necessary to assess not only the company as it exists at the time of the transaction but also the prospects it presents for the acquirer. It is advisable to work closely with financial experts in order to accurately estimate a price range, taking into account expected future results.

Several calculation methods exist, among which:

the asset valuation method,
the comparative method and
the discounted cash flow method

#5 The meeting between the seller and the buyer ⚙️

In addition to providing a better understanding of the business, the visit to the company and meeting with the seller, will allow the counterparts to better understand each other’s intentions. The meeting, the atmosphere of the exchanges and the relationships that are created are all indicators of the compatibility of both parties’ projects. Some companies are structured around their owner managers to such an extent that they are an asset in their own right. The more significant the influence of certain managers or owners, the more the transition will need preparation. In this case, it is possible to agree on a support contract that formalises a period of mentoring between the transferor and the transferee to best organise the transition of teams, customers and suppliers.

#6 The letter of intent 📄

The letter of intent (LOI), is a legal document by which the parties formalise the framework and the conditions of the transaction, before the acquisition audits, and the conclusion of a memorandum of understanding. It is drafted by the potential buyer and expresses their intention to enter into negotiations with the seller. The letter of intent may or may not commit the buyer to complete the transaction on the stated terms, or allow either party the option to withdraw. The buyer usually asks to be the sole party in negotiations for a predefined period.

#7 Due diligence or acquisition audit 📁

Due diligence is an in-depth audit of the accounting, legal, tax and employment documentation of the target company, which allows the buyer to assess the reality of the presentation made. From a practical point of view, this information can be made available to the buyer and the auditors hired through a secure data room.

#8 The Memorandum of Understanding 📋

The Memorandum of Understanding is a document signed by both parties to validate the agreement reached during negotiations.

#9 After the acquisition, the integration 🤝

The integration phase will follow the signature of the memorandum of understanding and the deed of sale. This harmonisation phase is of major importance in order to maximise the successful combination of both businesses. Integration must ensure sustainable growth and aggregate profitability that is higher than that of each entity separately. It must be well prepared in advance: to prevent possible difficulties, especially in human resources management. Internal and external communication must be relevant, readable and consistent within each entity. The challenge is to ensure that staff members share a common vision of objectives and a common desire to create value.

Leveraged M&A transactions

The LBO

The LBO (Leveraged Buy Out) qualifies the purchase of a company by a holding company which mobilises a limited amount of capital and is financed mainly by debt, thus creating a leverage effect for the buyer. The debt is serviced by the holding company through the dividend income of the acquired company.

The MBO

Another type of M&A is the management buyout, which is an acquisition of the company by its management. Very often, the company’s employees do not have enough money themselves to complete the desired acquisition. The operation can then be carried out through the intermediary of external economic agents, either by borrowing from credit institutions or by calling on private equity investors. Again, the new managers will need to ensure the sustainability of the company’s growth so that it can bear the burden of the debt.

The MBI

Similarly, a Management Buy is the acquisition of a company, this time by external investors. It differs from the Management Buy Out by the nature of the buyers, who may have a more limited knowledge of production methods and do not work for the company. From a legal and financial point of view, it is the same technique as the MBO or LBO.

The BIMBO

An intermediate formula may be to form a group of both internal and external buyers, the latter bringing in their management skills: this is the Buy In Management Buy Out (BIMBO).

The Leverage Build-up

Leverage Build up consists of a company continuing its development by acquiring other players in the same sector or in similar activities, by relying on the leverage of debt. This strategy will allow an acquirer, starting with a single company, to form a group which will be able to reach a critical size through successive acquisitions.

The Joint Venture:
Another form of corporate matchmaking

Finally, the Joint Venture is an association between two or more companies with a common goal to strategically optimise expertise, skills and resources. However, unlike mergers and acquisitions, which are irreversible, the joint venture allows the two companies involved to continue to operate separately.

This content is not intended to be exhaustive and presents the main terms of an M&A transaction. In all cases, the success of this type of project must be based on in-depth strategic thinking, a detailed analysis of the risks, the value of the acquired assets, and the support of specialized M&A advisory services to ensure proper integration downstream of the operation.