Corporations can grow in two different ways: through expansion of their current business or through mergers and acquisitions. In this lesson, you'll learn about mergers and acquisitions. A short quiz follows.
Meet Alvin. He's the CEO of a computer gaming company. Alvin is impressed with an innovative computer graphics technique that has been developed by a small computer software gaming startup. In fact, he thought about developing a similar process, but it would be costly and time-consuming. Alvin knows the startup is struggling for money and may not make it another year without help. Alvin believes the startup would make a fine acquisition. A corporate acquisition occurs when ownership of one company is transferred to another company. The company being acquired is often referred to as the target.
Alvin will try to purchase enough shares of the software company so his company has the right to control it. Sometimes, shares between the acquiring company and the other company are swapped, as well as purchased, if the companies are working together on the acquisition. Once Alvin's company has control of the target company, his company can either run it as a separate business or absorb it.
Meet Mary. She's the CEO of a large doughnut franchisor with doughnut shops in every state and major city in the United States. She has a problem, though - nobody really cares for the coffee served at her shops. Mary knows about a small struggling coffee shop franchisor that hasn't done so well since it started to trade publicly on the stock market. But, she knows they make a great cup of java. Mary gets approval from her board of directors to pursue the merger of her company with the coffee franchisor.
A merger is a type of acquisition. If Mary is successful, her company will obtain a controlling share of the coffee company's stock. Mary will then absorb the company into her company. This means that the coffee shop will lose its identity and become part of Mary's company.
Meet Sharon. She is the president, founder and majority shareholder of the coffee company that Mary wants to acquire by merger. Sharon doesn't want to be acquired by Mary's company. Consequently, she is defending her company from a hostile takeover, which is an acquisition that is not approved by the management and board of directors of the company being acquired.
Sharon can use some specific tactics, generally referred to as 'shark repellant', to fight a hostile takeover. These tactics are called shark repellant because people who attempt hostile takeovers are often referred to as sharks. Let's take a look at different types of repellants:
- Golden parachutes are very generous severance packages offered to management, such as Sharon, if they lose their jobs because of a takeover. This makes buying the company more expensive.
- Tin parachutes are severance packages for employees if they are terminated because of a takeover. This may even make buying the company more expensive than golden parachutes because of the volume of the payout.
- A poison pill tries to dilute the value of the target company's stock. If the value of Mary's shares in Sharon's company becomes diluted, Mary will have to buy more shares to stage her takeover. This makes the acquisition more expensive and less attractive.
- Greenmail is an option. It is where the target company offers to repurchase the unfriendly company's stock in the target company at a premium. Let's say that the stock of Sharon's coffee company is trading at ten dollars a share. Sharon may offer Mary $12 a share to go away.
- Sandbagging can also be used. Sandbagging is trying to stall the process, sometimes hoping that a better company comes along to buy the target company. The more attractive acquirer is called a white knight.
- A Pac-Man defense occurs when the target company tries to take over the company trying to take it over. For example, Sharon may try to turn the tables on Mary and buy the doughnut company.
- Scorched earth (or a suicide pill) occurs when the target company decides to sabotage its own company to make it unattractive for purchase. For example, Sharon could spend all the company's cash reserves, sell off lucrative assets and incur a large amount of debt.
Let's review what we've learned. Sometimes companies will seek to expand their business by acquiring other companies. A corporate acquisition occurs when a company obtains a controlling ownership interest in another company. The acquiring company may decide to operate the newly acquired business as a stand-alone company, or it may decide to absorb the company into itself, which is called a merger. In a merger, the target company ceases to exist and becomes part of the acquiring company. A hostile takeover is an acquisition that is resisted by the management and board of directors of the target company. The target company may use different tactics to make the purchase unattractive to the acquiring company.
After watching this lesson, you should be able to:
- Define and explain acquisitions, mergers and hostile takeovers of companies
- Describe some 'shark repellant' methods