Acquisition as a Strategy to Increase Shareholders Wealth

Acquisition is a procedure through which a business purchases the majority or all shares of a target company. In essence, it is a takeover and a corporate strategy used by businesses to earn a positive return. Some takeovers result in increased shareholders’ wealth while others do not.

Reasons and Benefits

The main reason is diversification as to reduce risk. Exposure to risk increases when a company invests heavily in one industry or sector. Companies facing the prospect of bankruptcy often look for a business to acquire them. Corporations and large companies have liquid assets, access to sources of financing, and good cash flow management practices. Acquisition may also improve the chances of companies to gain access equity and debt financing. Tax benefits are another advantage for companies with net losses. Tax loss carryforward applies when losses are reported on the tax return and are used to reduce liabilities.

Hostile Takeover

Sometimes acquisitions take the form of hostile takeovers. This occurs when the management of the target firm is unwilling to negotiate with the acquirer. Then the target company is purchased against its will and ceases to exist. There are different reasons why hostile takeovers occur. One reason is that the target company is acquired for less than the potential profits to be made. Another reason is to gain access to the target company’s technology, know-how, assets, brand name, customer base, and distribution channels. The factors are the same for hostile takeovers and friendly acquisitions. However, hostile takeovers occur when the CEOs feel that the terms are unfair, they would lose their jobs, or the value of the company would decline. Sometimes a group of investors or a company purchases enough stock to proceed with acquisition. They already have controlling interest.

There are different ways to avoid hostile takeovers, including dual-class stock, staggered board of directors, supermajority, and the golden parachute. The golden parachute, for example, is a provision that offers benefits to CEOs, top executives, and managers in the event of a takeover. It is an agreement under which the executives are paid large bonuses, either in stock or cash, when the company ceases to exist. CEOs receive severance pay if their company changes hands and their employment contract is terminated. Supermajority is another form of defense against hostile takeovers. For acquisition to take place, 70 or 80 percent of the stockholders should vote in favor of the transaction. Dual-class stock enables businesses to issue and offer stock with no or little voting rights. The voting stock is reserved for the owners. Finally, a staggered board of directors is a strategy that protects the board from replacement. Some members of the board are elected every 4 years while others – every 2 years.

Other Types

There are different types of takeovers, including backflip, reverse, and friendly. Reverse takeovers occur when a public company is acquired by a private business to avoid initial public offering. This is a strategy that allows private companies to become publicly traded. IPOs are associated with hefty fees that are thus voided. A backflip takeover is another variety whereby the acquirer becomes a subsidiary of the target company. This usually happens when the target company is small but its brand name is well known. A friendly takeover occurs when the transaction is approved by the top executives of the company to be acquired.

Risks Associated with Acquisition

The integration of new product lines, technologies, and marketing strategies may require different managerial practices, monitoring, and financial strategies. The target company has competitors, store customers, and business partners that are different from the acquirer’s customer base and competitors. Risks are also associated with unanticipated costs, delays, and other issues that arise with the integration of systems, staff, operations, and business practices. Other risks involve the sales volume, rates of return, and profits on the investment made. Some target companies require significant investment in new machinery and equipment. Business loans, money owed to suppliers, and other liabilities are another factor. Finally, risks and uncertainties also relate to the ability of the acquirer to develop new marketing strategies, launch new product lines, implement good practices, and maintain product licenses.

Related Articles

Mergers and Acqusitions to Expand and Diversify Operations
The term mergers and acquisitions refer to the process of joining or purchasing other companies. Usually a merger involves two companies that are similar in type, operations, stature, or size. With acquisitions, one company buys another that is smaller in size. The latter then becomes a subsidiary...

Venture Capitalists Offer Financing and Know-How
Venture capital is financing offered to high-risk, high-potential businesses. It is usually investors that offer capital to small companies and start-ups in exchange for high returns. Venture capitalists or VCs include large financial establishments, investment firms, and corporate investors....

Investment Banking, Products, and Risk Management Solutions
Investment banks are financial enterprises that specialize in debt financing, equity underwriting, and mergers and acquisitions. They provide capital raising services and financial advice to government agencies, institutions, and corporations. Investment banks feature a wide array of products and...

Due Diligence as a Method for Accurate Assessment
Due diligence is an audit of an investment or a business opportunity. It is conducted before signing a contract. This is a pre-transaction investigation of a company or person to determine their suitability for becoming a business partner. The investigation includes a reconciliation, management,...

Follow Tessa on