Complete Guide to Business Takeovers and Mergers

With the stock market taking quite a tumble in 2022 and valuations looking cheaper, business takeovers and mergers are becoming more common. 

But how do these types of acquisitions work? What’s the difference between a takeover and a merger? And what impact do these processes have on investors?

Let’s break it down.

What is a business takeover?

A company takeover takes place when a company that is listed on a stock market is bought by another company. 

Sometimes the business doing the buying will also be a listed company itself. But it’s not necessarily listed on the same stock exchange. For example, a US public company could acquire a UK public company. 

Alternatively, it could be a private firm doing the buying. In this case, you may see the phrase “being taken private” in reference to the company being bought.

What’s the difference between a merger and a takeover?

A corporate merger shares a lot of characteristics with a business takeover. The key difference is that in a merger, two or more companies have agreed to unite into a single entity with equal levels of ownership and control. 

Typically, the companies involved in a merger are roughly the same size.

How does a company takeover work?

The basic process is the same for whoever is doing the buying. A formal offer is made to the shareholders of the target company that’s being bought. These shareholders get to vote on whether to accept or not. If a sufficient number of shareholders agree, then the purchase goes ahead.  

When the target business is significant in relation to the purchaser’s size, then the purchasing company’s shareholders may also be asked to vote on the deal.

Understanding business takeovers in the UK

Takeovers of UK-listed companies are subject to a detailed document called The Takeover Code that runs to over 400 pages. It is designed to ensure shareholders are treated fairly, given an opportunity to decide on the merits of a takeover, and afforded equivalent treatment. 

An organisation called The Takeover Panel ensures The Takeover Code is followed by all parties involved. 

However, it is important to understand that neither The Takeover Panel nor Code decide on whether an offered price is fair or whether the deal makes sense for the businesses concerned. That is for the shareholders to decide for themselves.

They also don’t rule on whether the purchase is in the broader national interest, as that is the government’s remit. 

Are acquisitions good for shareholders? The research on this seems to indicate takeovers are usually better for the target company’s shareholders than for those of the purchaser. Individual cases will depend on the price paid and how good a fit the two companies are. Unfortunately, these factors are both quite difficult to judge before the transaction takes place.

Reasons for business takeovers

There are lots of reasons why one company might want to buy another. It may want to increase its market share, expand into a new line of business, or acquire a new product or technology. A company may also look to expand geographically by buying a similar company in another country or region.

Cost savings, also known as synergies, are often cited in takeovers where companies feel making their operations bigger will make them more efficient.

Sometimes a company takeover could be defensive, making a business larger so that it’s less likely to become a takeover target itself.

And the ego and pay packets of company directors no doubt play a role as well. Some people want to preside over ever-bigger operations or feel a larger company will provide a good reason for their salary to increase.

Unfortunately, some companies also buy businesses to disguise that their core business isn’t growing that quickly or is not that profitable. It’s harder to see underlying trends in the financial statements when a company regularly buys new businesses.

The company takeover process

There are a number of ways a takeover deal may unfold, but let’s take a look at the common acquisition process.

1. Rumours start to circulate

First, there could be a press rumour that one company wants to buy another. The shares of the target company may rise as a result of this.

If the rumour is true, the target company may confirm that it has had discussions with one or more parties but that no formal tender offer has been made. It’s usually at this point that the rules in The Takeover Code start to apply, such as an increased level of disclosure for larger share transactions.

2. Formal tender offer announced

Assuming discussions continue, a formal tender offer may then be announced. Sometimes the company buying will offer its own shares as payment, or sometimes it will offer an all-cash deal. It could also offer a mixture of cash and shares. If shares are offered as part of the deal, then the value of the offer will move up and down in accordance with the purchaser’s share price.

The amount offered over the current share price varies a lot from takeover to takeover. A typical bid is made at a premium of 20%-30%, but significantly higher or lower amounts are not unheard of. 

It could be that the target company’s share price has already increased in recent weeks or months on the expectation that a corporate takeover could be announced even though nothing has been said through official channels. 

3. Shareholder voting

A timetable will be set out for the formal vote, and a detailed offer document will be sent to shareholders so that they have plenty of information on which to base their decision. 

The purchaser will normally set a minimum level of acceptance for the deal to proceed. In the UK, this is typically 90%. Company law dictates that once this level of shareholders agrees to the deal, the remaining shares can be compulsorily purchased on the same terms. This means the purchaser gets to own the whole company and isn’t left with a handful of minority holders to deal with. 

4. Regulatory approval

Assuming shareholders of both companies vote in favour, the acquisition then needs approval from regulators. This is to prevent monopolistic situations that damage competition needed for a healthy marketplace. 

The regulatory review process also ensures there is no risk to national security. This typically only applies when an international company is performing the acquisitions, usually within the defence sector.

It’s often useful to watch what the target company’s share price does after an offer is formally announced. 

If the share price remains some way below the offer price, it may indicate the market has doubts about whether the deal will be approved. 

If it is noticeably above the offer price, it may indicate the market is expecting other bidders to come along or that the purchaser may have to increase the price to get the deal voted through. 

Therefore, it can pay to wait a little while to see what happens before accepting any takeover offer.

Types of company takeovers

A company takeover is often recommended by the target company’s directors if they think it is in the shareholders’ best interest. However, the purchaser may make what is called a hostile takeover if they can’t secure the board’s recommendation.

Recommended offers

Recommended offers tend to go through fairly smoothly, although sometimes they flush out another offer from another party. In this case, the board can withdraw their recommendation.

Once an agreement has been made that management believes is most beneficial for shareholders of both companies, the offer can be presented to be voted on. If both groups of shareholders vote in favour, the deal can proceed to regulatory review. 

A recommended offer is also sometimes referred to as a friendly takeover.

Hostile takeovers

Hostile takeovers can get quite bitter, especially if the firms concerned are long-standing rivals. They generally have a lower success rate. In this instance, the hostile bidder bypasses the board of directors and goes directly to shareholders to pressure the board to accept the deal. 

There are various tactics a board can use to fight against a hostile takeover bid:

• Poison Pill – Introduce a new policy where new shares will be issued to existing shareholders if a firm or individual buys more than a certain percentage of outstanding shares in order to dilute their stake.
• White Knight – Find another, more desirable company or individual to buy the company instead. 
• Destabilise the Balance Sheet – Load up the balance sheet with debt and other financial obligations to reduce the relative appeal of a buyout. This can be quite a risky move and is often left as a last resort.

Funding company takeovers

In many cases, the target company could be quite small compared to the purchaser and can be bought from the purchaser’s existing cash reserves. Sometimes, a purchaser will fund an acquisition by taking on more debt.

With larger deals, or where the purchaser’s shares trade on a high valuation, it may issue new shares to swap for those of the target company. This means there is no upfront cash outlay, but a higher level of dividends will need to be paid out in future due to the increased number of shares. 

Benefits of takeovers and mergers

Performing a takeover or merger involves a lot of work that may not necessarily turn out as expected. After all, there are countless examples of acquisitions going badly due to poor performance or higher-than-expected integration costs.

However, when executed correctly, takeovers and mergers can offer a lot of benefits:

1. Economies of scale – The larger size of the combined entity provides easier access to external capital, opening the doors to higher production capacity.
2. Economies of scope – Combining production pipelines to reduce overhead costs per product, resulting in higher profit margins.
3. Competitive edge – With greater control over the total addressable market, business takeovers can result in increased pricing power over the competition.
4. Better talent pool – Being a larger business makes it easier to attract new top-tier talent.
5. Better access to resources – During a merger, one firm may have a strong relationship with critical suppliers while the other has the production facilities to use those resources to create products. Combined, the companies can mutually benefit from higher earnings.
6. Revenue diversification – Merging product and service portfolios together results in a business with a more diverse base of customers to serve. This can reduce the risk of becoming over-dependent on a single customer.
7. Instant new market penetration – Introducing products or services into a market for the first time can be incredibly challenging. Through an acquisition, a company can gain access to a market of interest where the other business already has an established base to work from.

What happens to shares when a company is bought?

A few things can happen to the original shares when an acquisition is completed. And it depends on the type of funding used to execute the business takeover.

Suppose a deal is completed using all cash. In that case, shareholders of the acquired firm will be forced to sell their shares at the takeover price. As a result, a pile of cash will be added to their investment account.

Suppose a deal is completed using shares. In that case, shareholders of the acquired firm will see their original shares disappear and be replaced with new shares of the company that performed the acquisition.

Suppose the deal is completed using cash and shares. In that case, shareholders of the acquired firm will see their original shares be replaced with new shares of the acquiring company and also have cash arrive in their investment account.