What is a Merger?

A merger is a transaction through which two companies join forces to form a new company. The new company issues new shares of stock, and each of the companies’ previous shareholders get an ownership stake in the new firm. Companies merge for many reasons, including to enter new markets or increase their offerings. A merger is different from an acquisition, which is when two companies combine because one buys the other. Mergers are less common than acquisitions, since it’s pretty unusual that two companies on equal footing both benefit from combining their operations and leadership.

A merger is like a couple getting married…

When two people marry, they combine their families and often their finances to form one cohesive unit. They likely live together, and their extended families suddenly have a connection to one another. They might combine bank accounts and save for future goals together. Similarly, companies undergoing a merger form a new family of sorts. Their employees suddenly become coworkers, and their finances and operations meld together.

A merger is a transaction in which two separate companies combine their assets to form a new company under a single ownership and management structure. Mergers often occur between companies of a similar size when the deal will benefit both firms.

One of the most famous examples of a successful merger took place in 1999 between the oil and gas companies Exxon and Mobil. The company they formed, ExxonMobil, is now the largest publicly traded oil and gas corporation in the world.

When two companies enter into a merger, they consolidate into a new business entity. In some cases, the companies continue to do business under the name of one of the companies. Other times, they join forces under a new name. Often the company continues to trade on a stock exchange under the ticker symbol of one of the existing companies and issues stock to shareholders of the other company.

Most mergers fall into one of five categories:

A conglomerate merger is one between two companies in entirely different industries. A pure conglomerate merger occurs when the two companies have nothing in common — like a golf club manufacturer merging with a company that makes computers. A mixed conglomerate merger also occurs between two companies in unrelated industries, but with the hope of a product extension.

A horizontal merger occurs when two companies in the same industry, often direct competitors, merge. In this type of merger, the two companies usually sell the same product or service. The merger between T-Mobile and Sprint is an example of a horizontal merger, as the two were previously direct competitors.

A vertical merger takes place between two companies producing separate products used to make the same end product. In other words, the companies exist at two different points within the same supply chain. An example would be a company that produces silicon computer chips merging with a firm that makes laptops.

A market extension merger is between two companies that sell the same product in separate markets. This kind of merger can help firms expand into new regions. For example, suppose a yoga company with studios across the Northwest merged with a similar company in Southern California. The two hadn’t been competitors, but now they work together to operate in both regions.

A product extension merger occurs between two companies in the same market that are not direct competitors but sell related products. An example would be a company that sells workout clothes merging with a company that sells exercise equipment.

Every merger looks different — Some happen relatively quickly, while others are the result of years of effort and negotiations. In general, they go through the same basic steps:

1. Identify a target company.The first step in the process is finding a company to merge with.
2. Hire third-party services. When it comes to mergers and acquisitions, companies don’t generally go it alone. Instead, they hire professionals like lawyers, accountants, and investment banks to help facilitate the process.
3. Perform due diligence. Before companies close the deal, they generally do in-depth research on the other company and its executives. They want to know who they’re getting into business with.
4. Perform a valuation and start negotiation. When two companies enter into a merger, they usually undergo a business valuation, which is a way of assigning financial worth to each firm. They also need to negotiate the terms of the merger and sign and file the necessary paperwork.
5. Implement the merger. Once the companies have signed the deal, it’s a matter of actually merging the two companies in practice. This may include logistical steps, such as crafting a new mission statement, moving to a different building, or restructuring departments.

People often use the terms “merger” and “acquisition” either interchangeably or as a single phrase to describe business deals. But these are actually two different types of transactions.

A merger is a transaction in which two companies combine to form a new entity. An acquisition, on the other hand, is a transaction in which one company buys another. In this type of business deal, the acquiring company — the one doing the buying — fully absorbs the acquired company (target company).

There are many reasons why two companies might choose to merge to form a single company. A regional company that wants to expand into other geographies may decide to enter into a market extension merger. A company that wants to expand its offerings may enter into a product extension or conglomerate merger. A firm that wants to make its supply chain more efficient might undertake a vertical merger.

When it comes to investing, many experts recommend that investors diversify their portfolios. Rather than putting all of your money into one stock, spreading your money around into different stocks, bonds, mutual funds, and other investments can help reduce your risk of losses if one company or industry performs poorly. Companies can do the same by entering into mergers to diversify their offerings or geographic reach.

Companies may also enter mergers to access the funds, technology, and talent they need to grow or develop new products. Or they might choose to combine with another firm to cut costs or reduce competition.

Entering into a merger can have a lot of advantages for companies. First, mergers can allow both companies to increase the number of customers available to them, by increasing market share or expanding into new areas. If two companies previously controlled 25% of the market each, they can merge to control 50% of the market. Or two companies that operate in separate regions each gain a new customer base by merging.

Mergers can also offer internal advantages to companies. For example, they can gain access to one another’s in-house expertise and technology. They may be able to streamline operations by making a supply chain more efficient or negotiate lower prices on materials thanks to larger orders. If one company had an element that gave it a competitive advantage, or an edge over rivals, both companies can now enjoy that benefit.

Mergers sometimes come with downsides, too. Some mergers, especially horizontal mergers between two direct rivals, can reduce competition in the market and create a monopoly or near-monopoly. A monopoly is when one company dominates a particular industry without the threat of competition.

When competition in an industry falls off, consumers can suffer by facing higher prices, fewer choices, and lower-quality products. In the US, the Federal Trade Commission (FTC) monitors potential mergers to make sure they aren’t violating antitrust laws (federal laws that promote open markets).

Mergers can also come with disadvantages for employees. Redundancies among staff may lead to layoffs. And it can be challenging to blend together two distinct company cultures.