What is a Merger?

Published by Thomas Herold in Corporate Finance, Investments, Laws & Regulations

'Merger' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

A Merger refers to a financial transaction which combines two preexisting companies into a single larger resulting firm. A few different kinds of mergers exist today. There are a variety of reasons for why companies engage in such mergers. These mergers and acquisitions often go through with an eye to extending a firm’s customer base and product reach, increasing its market share, or moving into new markets and industry segments. In the end, the ultimate motivation is to make shareholders happy by adding shareholder value.

These combinations occur as two firms join forces into a new larger single company. They are nearly identical to takeovers and acquisitions. The main difference lies in the stock shareholders of each firm holding on to an interest in the share of the new corporation. With acquisitions though, a single company buys out all of or a controlling interest in the stock of the target company. This leads to an unbalanced ownership within the newly formed corporation. Practically the whole process of such mergers is generally kept under wraps so that the members of the investing public are completely unaware of it until after they are announced.

Most personnel at both companies are kept in the dark as well. In fact, the lion share of such merger efforts fail. With the majority of them completely secret, it is hard to say with any accuracy the number of possible mergers that become discussed and considered any year in question. The number ought to be extremely high as the quantities of successful ones prove how desirable such mergers are for a great number of corporations.

There are so many different explanations for why two firms wish to combine. Some of these are ideal for shareholders while others are actually not. A profitable company could be combined with a loss-making firm. This would allow the profitable company to employ the losses of the losing target as a tax write off against its own considerable profits. It would simultaneously grow the entire new corporation.

A good reason for these types of combinations is to boost the market share of a given firm. This is especially helpful with bigger corporations which cannot easily grow their market share organically any longer because of their sheer scope and size. When major competitors combine, the new company might be able to overwhelmingly dominate the industry, providing it with a wide range of choices in setting prices and buyer incentives. In these cases, the Sherman Clayton Anti-Trust laws often come into play to stop the merger and prevent the formation of a new monopoly.

There is another popular motivation to combining two existing companies. When they make products which are distinctively different yet still complementary, it presents an opportunity for cost savings. It could be that the acquiring firm wants to obtain the assets of a target firm which is a part of its product supply chain. As an example, there could be significant manufacturers who wish to obtain control over the warehousing chain. This would enable the buyer to save considerable costs on warehousing and to earn profits from the business it buys out at the same time.

A real world tangible example of this type of merger occurred when PayPal merged with eBay a few years ago. eBay became capable of sidestepping the considerable fees it had to pay PayPal previously. The complementary product line was actually a good match also.

It is usually investment bankers who handle the particulars details of and arrangements in a merger. They help with the transfer of ownership of the company itself via stock sales and strategic issuance. This does give incentive to investment banks to encourage mergers between existing clients. It could happen even when a merger would not be in the best interests of the two companies’ underlying shareholders.

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The term 'Merger' is included in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.