What is an Acquisition?

An acquisition is like adopting a child...

During an adoption, a family brings home a new, smaller human. During an acquisition, one company takes on another, often smaller, one. Parents adopting a child are looking to grow their family and gain the benefits that the new child brings, like an increase of joy and love in the home — but sometimes the new addition can cause trouble, too. Similarly, a company may hope to gain advantages from bringing another company into the fold, but it can run into pitfalls along the way.

Chances are you’ve heard of acquisitions among larger firms, like the Amazon/Whole Foods deal. But acquisitions also happen with small- to medium-sized companies.

Larger companies often acquire smaller ones that show signs of growth potential in areas where they want to expand. These smaller companies often have products that are similar to those of the larger firm. For example, when Facebook acquired the messaging app Whatsapp for $19 B, it allowed the social media platform to bring in revenue from more sources and to offer more diverse services. Facebook realized that many of its users travel and need to contact each other for free, regardless of their locations; WhatsApp’s technology would allow them to do that.

Companies may also look to acquire smaller competitors before those competitors expand and become threats. In that case, they may tempt the smaller startups with substantial cash or stock payouts as reward for acquisition. Those companies can opt to take this compensation and benefit from the larger company’s resources, instead of risking long-term business failure.

These terms might sound the same, but they have entirely different meanings and applications in this context:

• Acquisition. In an acquisition, the acquiring company absorbs the target company.

Acquisitions generally occur between a larger and a smaller firm and are done with friendly intentions. Most of the time, the smaller company’s board of directors approves of the acquisition, since it would mean access to the larger company’s resources. Both parties review each other's assets, financial statements, and market conditions to ensure the acquisition will be a win-win situation for everyone.

• Takeover. A takeover is similar to an acquisition, but it’s usually a hostile event. For example, a larger company may take over a smaller company, even if the smaller company’s board of directors doesn’t approve the transaction. Takeovers often occur when a larger company wants to eliminate competition and dominate the market.
• Merger. Mergers are mutually beneficial arrangements that generally occur between similar-sized companies, although they can happen between companies of all sizes. Companies that merge are equals and often want to join forces to gain new employees, technology, resources, and access to the market. Both companies believe that a new, stronger single entity will be beneficial to all parties. One example of a successful merger occurred between oil giants Exxon and Mobil in 1998. These two powerhouses joined forces for $75B when global competition was fierce and oil prices were low. Shareholders can sometimes also benefit from mergers, as they have the potential to increase the stock price in the long run.

Unfortunately, mergers don’t always have a happy ending. Take the AOL and Time Warner merger –- an event that is often referred to as the worst merger of all time. Time Warner wanted an online presence and access to AOL’s millions of subscribers. AOL wanted access to Time Warner’s cable network and content. It sounded like a win-win. Unfortunately, the cultures of the two businesses clashed to such an extent that it made collaboration difficult. Then came the burst of the dot-com bubble, when AOL’s value tumbled from $226B to roughly $20B. The rest is history.

• Lower costs. The acquiring company may benefit from lower costs. For example, the acquisition might increase its capacity to produce goods or provide services; it may even receive discounts from suppliers for larger orders. An acquiring company can also lower costs by laying off employees doing the same work.
• Exposure to different audiences. Acquiring a company can provide the acquirer with opportunities to access new markets and gain new clients. For example, if a retail company acquires another one overseas, its customer base may grow to include the new overseas market. In gaining access to different products, the acquirer may also find opportunities to cross-promote to its customers. A surf shop that acquires a paddleboard store, for example, might then be able to sell both types of boards, as well as related products its customers didn’t know they wanted before.

• Culture problems. Acquisitions can cause culture clashes within the employee population. Companies that have polar opposite cultures might find that their workers aren’t as willing to collaborate. This dynamic can cause a toxic work environment that makes employees dread going to their jobs. No one wants that.
• Increased debt. Acquiring a company is not cheap. There are many expenses, from paperwork and attorney fees to accounting costs and asset prices. These expenses can add up and leave the acquiring company with significant debt.
• Redundancy. If the acquired company is too similar, the acquiring company may run into redundancy issues, leading to layoffs and low morale.

Finding the right company to acquire can be tricky. In fact, buyers routinely overestimate the expected benefits of acquisitions while underestimating the one-time costs related to the purchase.

If you’re considering acquiring another business, it’s critical that you thoroughly assess that business’ current market value and financial standing, as well as any potential obstacles you may face, such as cultural clashes.

Here are a few characteristics to look for:

• Good financials. It’s important to ensure that the business you’re looking to acquire is making a good profit, is growing well, and has minimal debt. Before you make a move, be sure to thoroughly examine the company’s financial statements,including balance sheet, income statements, and cash flow statements, to avoid any surprises.
• Minimal legal trouble. Lawsuits can be very costly and can also negatively impact a company’s reputation, reducing sales. Take a good look at the public image and legal history of the business you’re interested in as you’re doing your research.
• Compatible culture and policies. Since company culture is so crucial to success, look for a firm with similar Human Resources policies and benefit plans. If employees are used to flexible paid time off but after an acquisition are now limited to 10 vacation days, they may become upset or even quit.
• Products and markets. You’d also be wise to assess how the products and services of the acquired company will overlap with yours. You’re looking for a sweet spot, a company with products that are similar but not too similar. When making your assessments, be sure to take into consideration industry standards, and other third-party information, which may help you remain realistic as you move forward.