What Is an Acquisition? Definition, Meaning, Types, and Examples

What Is an Acquisition?

An acquisition is a transaction wherein one company purchases most or all of another company's shares to gain control of that company. Acquisitions are common in business and may occur with or without the target company's approval. With approval, there is often a no-shop clause during the process. Although most people commonly hear about the acquisitions of large well-known companies, mergers and acquisitions (M&A) occur more regularly between small- to medium-sized firms than between large companies.

Understanding Acquisitions

As noted above, an acquisition is a financial transaction. It occurs when one business acquires the majority or all of its target's shares. The goal of an acquisition is to gain control of the target's operations, including its assets, production facilities, resources, market share, customer base, and other elements.

Companies acquire other businesses for various reasons. They may seek economies of scale, diversification, greater market share, increased synergy, cost reductions, or new niche offerings. Or they may simply want to cut out the competition. Other reasons for acquisitions include those listed below.

Acquisitions are usually friendly endeavors. They occur when the target firm agrees to be acquired, which means its board of directors approves of the deal. Friendly acquisitions often work toward the mutual benefit of the acquiring and target companies.

Both companies develop strategies to ensure that the acquiring company purchases the appropriate assets, and they review the financial statements and other valuations for any obligations that may come with the assets. Once both parties agree to the terms and meet any legal stipulations, the purchase proceeds.

Special Considerations

It is imperative for a company to evaluate whether its target company is a good candidate. The following are some of the key steps that acquirers may need to consider before considering whether they should go through with a deal:

1. Is the price right? The metrics investors use to value an acquisition candidate vary by industry. When acquisitions fail, it's often because the asking price for the target company exceeds these metrics.
2. Examine the debt load. A target company with an unusually high level of liabilities should be viewed as a warning of potential problems ahead. The target company may require the directors of the buying company to sign a whitewash resolution confirming the firm's solvency.
3. Undue litigation. Although lawsuits are common in business, a good acquisition candidate is not dealing with a level of litigation that exceeds what is reasonable and normal for its size and industry.
4. Scrutinize the financials. A good acquisition target will have clear, well-organized financial statements, which allows the acquirer to exercise due diligence smoothly. Complete and transparent financials also help to prevent unwanted surprises after the acquisition is complete.
   

Reasons for Acquisitions

Entering a New or Foreign Market

If a company wants to expand its operations to another country or a totally new market, buying an existing company in that country could be the easiest way to enter a foreign market.

The purchased business will already have its own personnel, a brand name, and other intangible assets, which could help to ensure that the acquiring company will start off in a new market with a solid base.

Growth Strategy

Perhaps a company met with physical or logistical constraints or depleted its resources. If a company is encumbered in this way, then it's often sounder to acquire another firm than to expand its own.

Such a company might look for promising young companies to acquire and incorporate into its revenue stream as a new way to profit.

Reducing Excess Capacity and Decreasing Competition

If there is too much competition or supply, companies may start making acquisitions to reduce excess capacity, eliminate the competition, and focus on the most productive providers.

Federal watchdogs often keep an eye on deals that may affect the market. For instance, acquisitions between two similar companies may have a harmful impact on consumers, including higher prices and lower quality goods and services.

Gaining New Technology

Sometimes it can be more cost-efficient for a company to purchase another company that already has implemented a new technology successfully than to spend the time and money to develop the new technology itself.

Acquisition vs. Takeover vs. Merger

The words acquisition and takeover mean almost the same thing, but they have different nuances on Wall Street.

An acquisition generally describes a primarily amicable transaction, where both firms cooperate. A takeover, on the other hand, suggests that the target company resists or strongly opposes the purchase. The term merger is used when the purchasing and target companies mutually combine to form a completely new entity.

But, because each acquisition, takeover, and merger is a unique case, with its own peculiarities and reasons for undertaking the transaction, the exact use of these terms tends to overlap in practice.

Takeover

Unfriendly acquisitions are commonly known as hostile takeovers. They occur when the target company does not consent to the acquisition.

Hostile acquisitions don't have the same agreement from the target firm. So the acquiring firm must actively purchase large stakes of the target company to gain a controlling interest, which forces the acquisition.

Even if a takeover is not exactly hostile, it implies that the firms are not equal in one or more significant ways.

Merger

As the mutual fusion of two companies into one new legal entity, a merger is a more-than-friendly acquisition. This deal generally occurs between roughly equal companies in terms of their basic characteristics. This includes their size, customer base, the scale of operations, and so on.

The merging companies strongly believe that their combined entity would be more valuable to all parties (especially shareholders) than either one could be alone.

Example of Acquisitions

AOL was the most publicized online service of its time. It was extolled as "the company that brought the internet to America." Founded in 1985, it grew to become the United States' largest internet provider by 2000. Meanwhile, the legendary media conglomerate, Time Warner was being labeled an old media company, given its range of tangible businesses like publishing, and television, and an enviable income statement.

AOL Buys Time Warner

In 2000, in a masterful display of overweening confidence, the young upstart AOL purchased the venerable giant Time Warner for $165 billion. The deal dwarfed all records and became the biggest merger in history. The vision was that the new entity, AOL Time Warner, would become a dominant force in the news, publishing, music, entertainment, cable, and internet industries. After the merger, AOL became the largest technology company in America.

However, the joint phase lasted less than a decade. As AOL lost value and the dotcom bubble burst, the expected successes of the merger failed to materialize, and AOL and Time Warner dissolved their union:

• In 2009, AOL Time Warner dissolved in a spinoff deal.
• From 2009 to 2016, Time Warner remained an entirely independent company. 
• In 2015, Verizon acquired AOL for $4.4 billion.

AT&T's Deal to Buy Time Warner

AT&T  and Time Warner announced it would buy Time Warner for $85.4 billion in October 2016, morphing AT&T into a media heavy-hitter. In June 2018, after a protracted court battle, AT&T completed the acquisition.

The AT&T-Time Warner acquisition deal of 2018 was as historically significant as the AOL-Time Warner deal of 2000. The Department of Justice sought to end the deal, saying the acquisition would hurt competition, leading consumers to face higher fees and bills.

The government lost its appeal in court and dropped the lawsuit. Despite this, AT&T made the decision to spin off its media assets, including Time Warner.

The Bottom Line

Financial transactions can range from simple buy-and-sell deals to acquisitions. Acquisitions take place when one company acquires most or all of another entity's shares. The purpose is to take over the target's operations. Other reasons for acquisitions may include to enter a new market, gain market share, or even cut out the competition. Although large-scale acquisitions make big news, these deals are fairly common in the small- to mid-sized business market.