Acquisitions based on the relationship between buyer and seller
There are four main types of acquisitions based on the relationship between the buyer and seller: horizontal, vertical, conglomerate, and congeneric.
Regardless of the type, in general, a company will acquire another company because its decision makers believe it will improve the bottom line — whether by increasing sales, decreasing costs, or otherwise. But each of these different types of acquisitions accomplishes that goal in a different way.
A horizontal acquisition is when one company acquires another company that is in the same business. For example, ABC Inc., a widget manufacturer, acquires XYZ Corp., another widget manufacturer.
Some horizontal acquisitions involve competitors. For example, in the case of ABC Inc. and XYZ Corp., they both sold to the same customer base.
However, a horizontal acquisition does not have to involve competitors. This would be the case if ABC Inc. sold widgets exclusively on the East Coast, while XYZ Corp. sold only on the West Coast.
The advantages of a horizontal acquisition include the potential to increase a company’s customer base and market share, and help a company expand its reach into new markets.
A vertical acquisition is when one company acquires another company that is in a different position on the supply chain.
The acquirer may be higher up on the chain. For example, ABC Inc. (our widget manufacturer) acquires a company that makes a key component part used by ABC Inc. to make its widgets. Or the acquirer may be lower on the chain. For example, ABC Inc. buys the company that has retail stores that sell its widgets.
Vertical acquisitions can bring in new income streams as well as lower costs of production and streamline operations.
A conglomerate acquisition is when the acquirer and target are in unrelated industries or engaged in unrelated activities. For example, a company involved in the real estate business acquires an insurance company. (Or either company acquires our widget manufacturer.)
Diversification is a main reason for a conglomerate acquisition. If one product or service is struggling, hopefully there are others that are doing well — helping to provide stability for a company.
A congeneric acquisition is when the acquiring company and the acquired company have different products or services but sell to the same customers. For example, DEF LLC provides a trademark searching and filing service for law firms and acquires LMN LLC, which provides a UCC searching and filing service for law firms. This kind of acquisition helps a company increase market share and expand its product lines.
Acquisitions based on method of acquisition: Statutory transactions
An acquisition can be accomplished in several ways. Statutory acquisitions include the merger, consolidation, and share or interest exchange.
One advantage of using a statutory transaction is that the documents that are filed to effect the transaction are relatively simple, and the contents are specified by statute. Non-statutory transactions are effected by complex, contractual documents.
Another advantage statutory transactions have over contractual transactions is that the owners of the surviving company who disapproved of the transaction must turn in their ownership interests. Therefore, the acquirer is not left with any disgruntled minority owners. With non-statutory methods, the results of a merger, consolidation, or share or interest exchange are prescribed by law and therefore are certain.
A merger is generally defined as a combination of two or more business entities in which the assets, businesses, and liabilities of all the entities are transferred to one entity. The one entity continues in existence, while all the others cease to exist. Because it is a statutory transaction, the requirements of the business entity laws of the buyer and seller’s state or states of formation must be followed for the merger to become legally effective.
In general, a merger requires the merger plan be drafted describing the terms and conditions. The plan must be adopted by the boards of directors or managers and approved by the owners of the entity that will not survive. In some cases, it may have to be approved by the survivor’s owners as well. After approval, the articles of merger must be filed with the Secretary of State or similar office in the acquirer and target’s state or states of formation.
When a merger is used to complete an acquisition, it is often done as a triangular merger. A triangular merger involves three business entities:
- a parent (the acquirer)
- its subsidiary
- the entity to be acquired (the target)
In general, the subsidiary will be newly formed for the sole purpose of assisting the parent in acquiring the target. In a triangular merger, the merger is between the subsidiary and the target. The acquirer is not a constituent in the merger. The end result of the transaction is that the target becomes a wholly-owned subsidiary of the acquirer.
However, because the merger was between the target and the subsidiary, the acquirer does not assume the target’s liabilities. This is the main reason for entering into a triangular merger — to allow the acquiring entity to acquire the target without assuming its liabilities.
There are two kinds of triangular mergers: forward and reverse. In a forward triangular merger, the subsidiary survives and the target disappears. In a reverse triangular merger, the target survives and the subsidiary disappears.
Because the target survives the merger, both the acquiring and acquired business entities remain in existence. Therefore, the reverse triangular merger is useful where the loss of identity of a constituent would cause problems — such as where the target was organized under a special statute in which organization is difficult or where it possesses rights, licenses, or contracts that do not permit assignment.
A consolidation is a statutory transaction in which two or more business entities combine to form a new business entity. All of the business entities existing before the consolidation disappear as a result. The assets, businesses, and liabilities of all the disappearing entities are transferred to the new one.
Consolidations are not authorized by all state business entity statutes. Therefore, the first step in effecting a consolidation is to check for statutory authorization.
If authorized, consolidations are effected in a similar manner to mergers. A plan of consolidation must be drafted and approved by the disappearing entities and articles of consolidation filed to effect the consolidation.
Share exchange and interest exchange
An exchange is another statutory method of acquisition that is provided for in some (but not all) state business entity laws.
In a share exchange, one corporation becomes the owner of all the outstanding shares of one or more classes of another corporation. It is an exchange that is binding on all the shareholders of the acquired class of shares.
An interest exchange is the same type of transaction involving the exchange of ownership interests in an unincorporated entity. A plan of exchange must be drafted and approved and articles of exchange filed to effect the transaction.
An exchange accomplishes the same end as (and can be used in place of) the reverse triangular merger. In an exchange — like in a reverse triangular merger — the acquired entity does not go out of existence. It becomes a subsidiary of the acquirer. The advantage of the statutory exchange over the triangular merger is that there is no need to form a subsidiary to accomplish the transaction.
An exchange may also accomplish the same ends as a direct, non-statutory acquisition of shares or ownership interests. The advantage of the statutory exchange is that the acquirer only has to obtain — in most cases — a majority vote for approval, with the exchange thereby becoming binding on all of the holders of the acquired class of ownership interests. In order for the acquired entity to become a wholly-owned subsidiary in a contractual acquisition, the acquirer would have to convince all of the owners to sell their interests.
Acquisitions based on method of acquisition: Non-statutory transactions
Non-statutory acquisition methods include the asset purchase and share or ownership interest purchase. Non-statutory methods can provide more flexibility because their effects are not statutorily prescribed.
In addition, unless all of the constituents are of the same entity type and from the same domestic state, statutory transactions will have to be effected by complying with at least two statutes — which, in many cases, will be inconsistent, thereby adding a level or complexity.
Furthermore, non-statutory acquisitions can be entered into regardless of the state or entity types of the buyer and seller. Consolidation and interest exchanges are not available under all business entity laws and while mergers are provided for in all business entity statutes there may be limits when the merger involves certain unincorporated entity types.
Share acquisition and interest acquisition
A share acquisition is when one company acquires all interest or a controlling interest in the stock of a corporation by directly buying the shares from the shareholders. The result of a share acquisition is that the acquired corporation becomes a subsidiary of the acquirer. The purchase price may be cash, stock in the acquirer, or other property.
When the acquirer purchases the ownership interests of an LLC or another form of unincorporated business entity, the transaction is generally referred to as an interest acquisition.
An advantage of a share or interest acquisition is that no statutory requirements (such as holding a shareholders’ meeting) must be met. The acquirer simply contracts with the target’s owners to buy their interests.
A disadvantage of a share or interest acquisition is that the acquirer may have to deal with a large of number of sellers. This can be time consuming and expensive.
Another disadvantage is that the owners of the target who refuse to sell are not eliminated by effect of law as in a statutory transaction. Therefore, they will still be around and entitled to vote, inspect records, and assert their other rights.
An asset acquisition occurs when one business entity purchases all, or substantially all, of the target’s assets, other than in the ordinary course of business. After the transaction is completed, the target retains its separate existence. The purchase price may be in cash, stock or other ownership interests, or other property.
An asset acquisition differs from a share or interest acquisition in two significant ways. First, in an asset acquisition, the target does not become a subsidiary of the acquirer. Second, the purchase price is paid to the target business entity, not to the target’s owners.
A principal advantage of an asset acquisition is that, as a general rule of common law, the acquirer does not assume the seller’s liabilities. A principal disadvantage is that it is a complex form of acquisition. There are many issues to deal with including
- inventorying the assets
- deciding how to allocate the purchase price among the assets sold
- determining whether new licenses or permits will have to be obtained to operate transferred businesses
- deciding who will be responsible for repairing assets and completing works in progress
- determining whether the buyer will be bound by the seller’s labor, franchise, and other agreements
Hybrid two-step acquisition
Some acquisitions combine a non-statutory method (a share or ownership interest purchase) with a statutory method (usually a merger).
In the first step, the acquirer directly buys enough of the target’s shares (or ownership interests if the target is not a corporation) to ensure voting control. This is generally followed by a merger between the acquirer and target.
This merger results in the acquirer obtaining the rest of the shares (or ownership interests) and eliminating any minority owners.
Acquiring a company is a business strategy many companies favor to increase revenue, lower costs, grow market share, acquire new product lines, and generally improve the bottom line. There are several types of acquisitions and several ways to accomplish the acquisition. This article has examined both categories of acquisitions.
CT Corporation understands the complexity involved in completing an acquisition and has assisted thousands of business entities in completing their transactions. Visit our mergers and acquisitions services page to learn more.
Key phases of a merger and acquisition deal