How do mergers and acquisitions work?

Mergers and acquisitions involve lengthy and often secret negotiations between two companies. The larger of the two firms often takes the first step, followed by deliberations between their boards. Here are the steps involved in merging or acquiring companies:

1. Creation of merger or acquisition strategy

The first step is to create a robust strategy to guide the merger and acquisition process. This document outlines the purpose of the transaction and the potential gains for the parties. It might also explain why one strategy is preferable over another and include a plan for convincing stakeholders.

2. Development of search requirements

The next step is to determine the criteria for identifying target companies. These requirements can depend on the smaller company’s market share, customer base, product lines, supply chain or geographic spread. This part of the process might also consider how to generate the appropriate funds.

3. Identification of targets

Next, the company identifies firms that satisfy its search criteria. These can depend on the market share, financial status, prospects and other factors that can help the acquiring company achieve its objectives. Note that in the case of bankruptcy, the target may already be in a working relationship with the interested company.

4. Acquisition planning

Once the company identifies potential targets, it contacts them with an initial offer. The target company’s response is often what distinguishes a merger from an acquisition. If the reply is friendly, the relationship can take on a mutual tone from the start. An unfriendly response can cause a hostile takeover of the smaller company.

5. Valuation

If the target company is amenable to a merger or acquisition, the acquirer requests information about its health. This provides valuable insight into the
company’s finances, product performance and other vital metrics that help the larger company make informed decisions going forward. For instance, the acquiring company might want to understand any debt that might come with an acquisition.

6. Due diligence

This involves a comprehensive analysis of the acquirer’s valuation of the target company. Auditors check the smaller company’s finances, customer/client base, market share, personnel, production capacity and other variables. Due diligence helps ensure that the acquirer made a correct valuation and reduces the chance of foul play.

7. Preparation of purchase and sales agreement

If the due diligence finds no serious errors in the valuation, the parties negotiate and sign a purchase and sales agreement. The contract transfers the
shares or assets of the target company to the acquirer. If the acquirer is buying shares, both parties agree on the ratio of the target company’s shares that make one share in the merged entity.

8. Discussion of financing options

Once the companies sign the purchase and sales agreement, the acquirer reveals the financing options it plans to use to execute the transaction. The last step is to close the deal and consolidate the companies according to the guidelines of their agreement. Both companies adjust to operational and
structural changes following the deal.