Merger | Definition | Importance | Reason | Compatibility problems


Growth is an essential ingredient in the success and vitality of an enterprise; and it can be effectively brought about by channelizing the firm’s capital into various assets in a step-by-step manner, both internally and externally by way of merger and acquisition.

The internal growth of a firm takes place by following the acquisition of assets and after financing them from external sources or by the retention of earnings. External growth can be brought about by the acquisition of another company.

merger and acquisition

What is a merger?

Merger(Image: Merger)

A merger is a combination of two corporations, as a result of which one loses its corporate entity. The surviving corporation acquires the liabilities, assets, personnel and much of the reputation of the fusing company.

A merger is fundamentally different from a statutory consolidation in the sense that it involves a combination of two companies, whereby an entirely new corporation is formed. Both the old companies cease to exist, and the share of their common stock are exchanged for shares in the new company.

When two companies of about the same size combine, they usually consolidate; when two companies differ significantly in size, they usually merge. Though mergers are not common, they have a market effect, whenever they do occur.

In deciding about a merger, the management should pay adequate attention to the following points:

  1. Reasons for entering into a merger;
  2. Alternative ways to finance acquisition;
  3. Problems of compatibility.

Reasons for Entering into a Merger

The reasons for entering into a merger are varied and complex. They are not mutually exclusive. Quite often, more than one reason is involved in a merger. A few important reasons for merger have been discussed in the following paragraphs.

Economic Benefits in mergers:

Substantial economic benefits can be achieved through a merger. Quite often, one company has some assets which are required by the second company; but the second company cannot obtain them or obtains them at a higher cost. A merger generally does away with these problems. It also checks duplication of efforts and facilities and promotes consolidation of a variety of operations.

When industrial companies merge, a firm with a product that complements an existing product line may fill out the line and increase the total demand for the product of the company. The realization of such economies is known as ‘synergism‘.

A typical example is that of the merger of an oil company with up to date technology in refining and a dynamic marketing organization with the producer of crude oil. Such a merger provides an excellent opportunity for gaining control over raw materials.

Existence of Tax-Loss Carry-Forward in merger:

An important factor in some mergers is the existence of tax-loss carry-forward. A company with cumulative tax losses may have little chance in future to utilize fully its tax-loss carry-forward. By merging with a profitable firm, it may be possible for the existing company to utilize the carry forward at the expense of the government. This would not be possible for either of the companies independently.

Benefit of Diversification in mergers:

Some companies go in for mergers to reap benefits of diversification. By acquiring firms dealing in different products or product lines, a company can reduce the uncertainty of its earnings. For example, an electric equipment company, facing a static demand for its established products, by merging with an electronic goods industry, can eliminate the uncertainty of its earnings to a large extent.

Merger and acquisition to boost Growth:

Normally, a company may not grow at a fast or balanced pace but can attain its objective by acquiring another company. It has been noted quite often that growth by acquisition may be cheaper than internal growth, because the numerous costs and risks involved in undertaking new ventures are avoided by the acquisition of a going and profitable concern.

Personal Factors for merger and acquisition:

In a tightly held company, the individuals, who are at helm of affairs, want their company to be acquired by any other company which has an established market for its stock. They may intend to do so by reason of their ill health or old age. The merger helps them in converting their stock into marketable securities or cash.

Alternate Ways to Finance mergers:

Once a merger possibility with clear benefits has been identified, the parties to the merger should start financial negotiations. This as a rule depends on the management of the two companies — their liabilities, their need for capital, their tax position, their desire to withdraw and remain active. Broadly speaking, in a merger, the final agreement will probably bear some of the variations in elements indicated below.

The financial and legal details of most mergers quite often become so complicated that final negotiations often drag on for a long time. Major economic benefits should therefore be taken into consideration in concluding merger agreements.

Problems of Compatibility in merger:

A merger is more than discovering economic advantages and negotiating a deal. If the amalgamation of two enterprises into a new one is not carried out efficiently and effectively, the expected benefits may not materialize at all. Below we have considered some of the possible sources of friction.

The nature and type of policies adopted by fusing organization differ so much that, for want of a proper synchronization, their living together may be virtually impossible. As a result, new policies and norms have to be established which have the good features of the fusing undertakings; and the people employed in them should be encouraged to accept new norms and methods of working and discarding the older ones.

For example, the manager of an electric switch gear company took over an electronic research firm and started working on developing a new electronic product line. Unfortunately, however, the attitudes and policies of the production were so alien to his team that most of the key personnel left the organization.

The status, role and personality of the executive should be given due weightage. If, as a result of the new pattern of management, some senior personnel are reverted or placed in difficult situations, they may develop negative feelings towards the new regime. Also, the breaking down of the old “role set” at times makes people uncomfortable in working in a newly formed group, which may breed interpersonal problems.

It has been noted that companies face a host of difficulties in actually reassigning the work because of technological and union complications. It goes without saying that a merger occasionally provides a fast and economical way of moving towards the company’s objective. But the management has to take a number of decisions to make it practicable. Before embarking on any merger programme, the company should, therefore, carefully weigh the benefits and consequences that it expects would flow from it.