Growth by acquisition is a powerful strategy that can help your company expand at a quick pace. While this sounds attractive for your company, succeeding at it requires careful planning and strategic logic. Acquisition refers to the process of a business acquiring a target company to build on the strengths of the company. There are a wide variety of acquisitions, meaning that there is no ‘correct’ strategy. As such, you need to consider all factors and weigh the pros and cons before deciding on how to proceed.
We will be covering everything you need to know about acquisitions to make an informed decision on the best and most value-creating acquisition strategy for your company.
Key Takeaways
Acquisitions occur when one corporation acquires partial or full shares in another company.
Common reasons for entering acquisitions are to accelerate the growth and competitive edge of the acquiring party.
Asset acquisitions are useful for acquirers looking to accelerate their corporation’s growth by way of specific assets yet wish to remain a separate legal entity.
Business acquisitions are useful for acquirers looking to achieve an increased production capacity and obtain opportunities to explore new sectors.
Table of Contents
- Introduction
- Key Takeaways
- Acquisition: Definition and Common Rationale
- Differences between Acquisitions, Mergers, and Amalgamations
- Acquisition Strategies: Asset Acquisition and Business Acquisition
- Asset Acquisitions
- Structure and Common Applications
- Factors for Success
- Asset Acquisition Agreements
- Key Terms
- Business Acquisitions
- Structure and Common Applications
- Factors for Success
- Asset Acquisition Agreements
- Key Terms
- Draft Your Asset/Business Acquisition with DocLegal.AI
- Future of Acquisitions
- Frequently Asked Questions (FAQ)
Acquisitions: Definition and Common Rationale
Definition. Acquisition means buying or obtaining an asset or object. In business terms, an acquisition refers to a corporate transaction to purchase another company partially or in full. An acquisition is also one of the three types of business combinations, the other two being merger and amalgamation.
Common rationales for Acquisitions. Through the acquisition, the acquiring company can benefit and obtain for themselves the strengths of the target company. The most common reasons include:
- Reducing business costs by developing a corporate production line or service line
- Reducing competition from other companies
- Expanding the business by growing through adjacent markets
- Opening up another geographical market
- Improving business performance by combining the perks of both companies, ie. synergy
Differences between Acquisitions, Mergers, Amalgamations
The term “mergers and acquisitions” (M&A) commonly pops up in corporate transactions. However, mergers and acquisitions are two separate processes and should not be conflated.
An Acquisition allows both companies to remain as separate legal entities while one of the companies becomes the parent company of the other company or acquires the assets of the other company.
A Merger combines two legal entities, with the stronger entity surviving and taking the assets and liabilities of the two entities.
An Amalgamation means that the assets and liabilities of the amalgamating entities are transferred or novated to a new entity and none of the original companies survives after the amalgamation.
How to Identify an Acquisition Target
Before choosing an acquisition strategy, you must identify a suitable target for acquisition that is valued at a reasonable price. Here are some guidelines to help you identify an acquisition target:
Price: Is it within your business’ range?
Examine target’s financials: Are their financial statements systematically organized? Will you be able to carry out due diligence?
Potential financial and legal risks of target: What is their debt load? Do they have an unusually large amount of outstanding litigation?
Acquisition Strategies: Asset Acquisition and Business Acquisition
Once you have identified a target, then you can choose an acquisition strategy, which should be based on initial due diligence.
This article focuses on two acquisition strategies: asset acquisition and business acquisition. Below are general overviews of each acquisition strategy, followed by a table detailing their advantages and disadvantages. Use the table as a guide to identify the best acquisition strategy for your business.
General overview of Asset Acquisition and Business Acquisition
In an Asset Acquisition, the buyer purchases all or some of the target company’s assets rather than the company's shares.
In a Business Acquisition (also known as “company” or “shares” acquisition), the buyer purchases a majority of the target company’s shares, which comes with legal obligations. The acquiring company would become the new owner of the target company, while they remain as different legal entities.
Asset vs Business Acquisitions: Advantages and Disadvantages
Asset Acquisition
Advantages
- Buyer can choose specific assets to purchase [1]
- Greater flexibility for buyer’s assumed liability: buyer can choose liabilities to take
- Buyer can avoid undesirable responsibilities and maximise business gains
- Buyer enjoys absolute autonomy over the asset purchased; no need for approval by shareholders from the target company
Disadvantages
- Acquisition process is time-consuming and complex
- Double taxation occurs for asset acquisition, as the buyer would be taxed separately as shareholders and as a corporate entity.
Business Acquisition
Advantages
- Buyer generally pays less tax by acquiring ownership of the target company
- Economies of Scale: Increased capital and production capacity
- Synergies: Growth in customer bases and market reach
- Access to new resources: exploration of new markets, diversify R&D possibilities
Disadvantages
- The use of assets still depends on the shareholder’s decision if protective terms for minority shareholders are in force.
- Liabilities are attached to ownership.
- The acquiring company cannot choose which part of the target company it would like to acquire. The buyer needs to take responsibility for undesirable items such as unprofitable financial status and unfulfilled legal obligations.
- Little protection to the buyer from assuming the seller's liabilities, especially when the liabilities are contingent or unknown.
- Complex integration of employees and higher initial cost
[1] The common assets acquired may include real property such as real estate and office equipment, as well as intellectual property such as copyright, trademarks, and patents. Similarly, the two companies maintain separate legal entities even if the acquiring company purchases all the assets.
Asset Acquisitions
Structure and Common Applications
Structure. An asset acquisition refers to the corporate purchase of another company’s assets, which constitutes real estate or intellectual property instead of its stock. It allows the acquiring company to gain possession of the beneficial or profitable assets selectively. The acquiring company is free from unwanted liabilities by acquiring assets instead of ownership.
Common applications. Two common applications of asset acquisitions are for insolvent companies and rejected buy-offers. For insolvent companies, asset acquisitions are a desirable strategy because the buyer is not interested in acquiring the entire company (due to its financial state) – bearing the debt and obligations only creates more trouble for the acquiring company. Therefore, the buyer would prefer to just acquire the assets, which costs less and brings less trouble.
For rejected buy-offers, asset acquisitions are a strategic solution in that it moves the acquirer towards a position of full ownership of the target company. An asset acquisition strategy is a business strategy used to gain control of a target company by acquiring assets instead of stock, when chances to buy enough shares to take over are slim. The buyer breaks up the target company into smaller pieces and acquires its key assets one at a time. Eventually, the target company becomes dependent on the buyer and would allow him/her to reap and acquire full ownership.
Factors for Success
- Ensure frequent and objective valuations of the target company; perhaps considering outsourcing the task of valuation to external financial advisers.
- Utilise the due diligence process to assess benefits of the target company and to let the due diligence process inform and shape the structure of the asset acquisition.
- Manage and integrate the target company and capture deal value effectively with a detailed integration plan
- Prepare financing plans, which should consider the impact on financial solvency and credit rating, and include scenario analyses for adverse developments
- Make management control to prevent biased decision-making in the acquisition process, particularly for inexperienced acquirers who heavily rely on external advisers
Asset Acquisition Agreements
An asset acquisition is kicked off by a letter of intent in which the buyer expresses their intention to purchase and acquire the addressee’s assets. After negotiation, due diligence will be conducted to confirm the material information and documents.
An asset acquisition agreement is a contract that governs the corporate transaction of the purchase of assets.
Now, we can move on to the key terms of an Asset Acquisition Agreement.
Key Terms
Buyer & seller. Like a business acquisition agreement, it is vital to specify the buyer and seller accurately. Make sure you give a detailed description of the acquiring company and the target company.
Purchased assets & price. In an asset acquisition, providing a clear and exact description of the asset purchase is probably the most important thing to do. Include as many details as you can. Make sure the details match with the descriptions on government records.
Here are the descriptions you should provide for some common assets purchased:
- Real Estate/Land: acreage, buildings, parking space, constructions
- Intellectual Property: copyright registration, patent registration, trademark registration Services: nature of service, equipment, training
Just like other agreements, you should also include the confirmed purchase price after negotiations. The valuation of the asset relies on its market price primarily. Its expected contribution to profits is also considered.
Method of payment. Similarly, in an asset acquisition, it is the buyer who can choose whether they want to pay in instalments or a lump-sum payment. If the transaction involves the seller financing, the buyer may remit a portion of the purchase price at the closing of the deal and simultaneously sign a promissory note for the remainder of the purchase price.
Representations and warranties. As previously mentioned, the warranty is an official legal document, which is someone who likes a disclaimer, ensuring that the information provided by the seller is true. It protects buyers by ensuring the quality of the asset bought. Breaching the warranties may result in termination of the Asset Acquisition Agreement, financial penalty, or even litigation.
In an asset acquisition agreement, it is essential to provide the following representations and warranties:
- Fitness of the asset for a particular purpose
- Condition or quality of the asset purchased
- The legal status of the buyer and seller
- Any other documents that relate to the liability the buyer undertakes
Requirements for closing the deal. The requirements for the acquisition to close should be stated clearly in the asset acquisition agreement. Common requirements include:
- Delivery of the purchase price
- Approval of the sale by third parties such as government agencies
- Completion of changes or repairments to assets prior to sale
- End of price adjustments
Business Acquisitions
Structure and Common Applications
Structure. A business acquisition refers to the corporate purchase of another company’s shares. It allows the acquiring company to gain control of the target company. Holding more than 50% of the target company’s stock (and/or other assets), allows the acquiring company to have an overriding decision-making power without the need for approval by other shareholders.
Common application. After years of business growth, a start-up company may start to generate an overall profit. Initial or early investors may wish to “cash-out” their investment by exiting the company. The two most common ways of exiting a company are:
- Selling it to an international giant company or
- Offering it on the stock market (this is called an initial public offering, as known as IPO).
Factors for Success
Beyond due diligence, the key to successful business acquisitions is effective integration. As noted in a McKinsey & Co report:
“The integration of an acquired business should be explicitly tailored to support the objectives and sources of value that warranted the deal in the first place. It sounds intuitive, but we frequently encounter companies that, in their haste, turn to off-the-shelf plans and generic best practices that tend to overemphasize process and ignore the unique aspects of the deal.”
To that end, here are three critical dimensions of integration to plan for when embarking on a business acquisition:
Culture: What are the values, mottos, and working styles of each party? Are they compatible with each other? Will the culture under the business acquisition be a synthesis of the preexisting cultures of the target and acquiring parties, or something new altogether?
Operations: Which party will be responsible for what? What are the plans of the key employees from the target party?
Communication: What will be the new channels of communication? How will these channels be established? Are they sustainable?
Business Acquisition Agreements
Negotiations are indispensable during business acquisitions. Usually, negotiations kick off with a Letter of Intent in which the buyer expresses an intention to purchase and acquire the addressee’s business.
After rounds of negotiations, due diligence should be conducted to confirm the material information and documents.
Now, let us get into the key terms of a business acquisition agreement.
Key Terms
Buyer & seller. This is perhaps the most vital part of the business acquisition agreement as it determines whether ownership is purchased validly. To ensure that it is valid, a detailed description of the acquiring company and the target company is needed. Most importantly, you should identify the correct buyer and seller as some joint ventures do not exist in one single legal entity. If you want to understand more about business entities and structures, you can check out our dedicated blog post here.
Price. The purchase price must be expressed clearly in writing as the buyer and seller often hold different views during the negotiation. The purchase price includes working capital, which means the amount of money needed for the day-to-day operation of the business during the acquisition.
The working capital may include:
- Inventory
- Accounts receivable
- Pre-paid items such as insurance or subscription services
Payment method. In a business acquisition, it is common for the acquiring company to make payments in instalments. With this payment method, the buyer will have to sign a significant down payment before signing a promissory note which outlines the amount of the payments and how long the buyer will take to pay off the seller. In some rare cases, resourceful buyers will make a lump-sum purchase.
Representations & warranties. Warranty is an official legal document that gives rise to liability when representations made, or information provided by the seller is untrue. It helps offer security to buyers in agreements. Typically, the warranties reflect the items discussed and disclosed during the due diligence process.
In a business acquisition agreement, representations and warranties usually comprise of the following items:
- The legal status of the business
- Authority of the Seller to transact business on behalf of the company
- Business structure
- Financial documents, including tax documents and financial statements
- Legal documents, including some text
- Employee information, including retirement plans and employee profiles
- Whether there are any pending lawsuits against the business
Requirements for closing the deal. A business acquisition agreement should clearly state the timetable the acquisition process will follow. Negotiations should only continue until the closing date, which should also be agreed upon by both the buyer and seller.
The following documents are required to be executed at the closing of the deal:
- Bill of sale
- Directors' agreement(s)
- Shareholders agreement(s)
- Resignations of directors and officers
- Lease information
This section also outlines any agreements that will go beyond the closing date, including:
- Protection of claims for breach of conditions
- Protection of claims for breach of warranties
Draft Your Asset/Business Acquisition Agreements with DocLegal.AI
There are various elements to look at when drafting acquisition agreements. Some considerations include the number of parties concerned with the joint venture, the separation of shares, and the goals of the joint venture. DocLegal.AI can help expedite the process of drafting the joint venture agreement, providing you with support tailored to your business’s needs.
Here are the asset/business acquisition agreements DocLegal.Ai can draft:
Asset Acquisition Agreement (Seller)
An agreement between a buyer and a seller regarding the transfer of existing or used assets (excluding real property). This agreement is drafted in favour of the seller.
Asset Acquisition Agreement (Buyer)
An agreement between a buyer and a seller concerning the transfer of existing or used assets (excluding real property). This agreement is drafted in favour of the buyer.
Business Acquisition Agreement (with Buyer's Guarantor: Seller)
An agreement between a buyer and a seller, where the buyer's parent guarantees the obligations. The warranties of the seller are included in a separate template. This agreement is drafted in favour of the seller.
Business Acquisition Agreement (with Buyer's Guarantor: Buyer)
An agreement between a buyer and a seller, where the buyer's parent guarantees the obligations. The seller's warranties are included in another template. This agreement is drafted in favour of the buyer.
Business Acquisition Agreement (Warranties)
This includes the seller’s warranties related to a business acquisition. It can be inserted as a schedule into the business acquisition agreement and is drafted in a neutral form.
Future of Acquisitions
Despite increasing interest rates, current valuations and unpredictable political landscapes, acquisitions continue to be an attractive option for corporations to accelerate their growth and adaptability. Here are some factors explaining why:
- Private Equity portfolios are ripe for sale.
- Corporations are focused on transactions to accelerate growth and achieve business transformation
- AI could be a catalyst for all sorts of transactions types
- Inorganic growth is required to overcome anaemic organic growth
Frequently Asked Questions (FAQ)
What is the most common acquisition strategy?
Improving the performance of the target company is one of the most value-creating acquisition strategies (McKinsey and Company). Ultimately, the most appropriate strategy will depend on the unique needs and aspirations of your business.
What are the stages in the acquisition process?
1. Assessment and initial review
2. Negotiations and letter of intent
3. Due diligence
4. Final negotiations and closing
5. Post-closure integration/implementation
What are the most common sources of risk in acquisition?
A common source of risk, especially at the negotiations phase of the acquisition process, is parties acting too quickly with limited information. Growth by acquisition is inorganic. It is marked by time pressures, increased complexity of corporate functions, and sometimes conflicting interests. Accordingly, parties are prone to 'tunnel vision' and 'deal fever', which when managed poorly, may lead to potentially risk or fatal deals.
What are the differences between acquisitions and takeovers?
Acquisitions:
- Usually friendly in nature
- Require consent from the target party to the acquisition
- Neither party are forced into the acquisition process
- In shares acquisition, the acquiring party automatically acquires the controlling interest without having to purchase large shares of the target party
- All parties involved have equal amounts of power in the acquisition process
Takeovers:
- Usually hostile in nature
- Do not require consent from the target party
- Target party is forced into the takeover process
- Implication of inequality amongst the parties involved in the takeover process, even for takeovers that are not hostile
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Authoritative Links
[1]https://kpmg.com/kpmg-us/content/dam/kpmg/frv/pdf/2023/handbook-asset-acquisitions.pdf
[3]https://www.investopedia.com/terms/a/acquisition.asp
[6]https://www.investopedia.com/terms/a/asset-acquisition-strategy.asp
[7]https://corporatefinanceinstitute.com/resources/valuation/asset-acquisition/
[10]https://www.investopedia.com/ask/answers/203.asp
[11]https://www.pwc.nl/nl/assets/documents/pwc-mergers-acquisitions.pdf
[12]https://www.pwc.com/gx/en/services/deals/trends.html
[13]https://www.forbes.com/sites/forbestechcouncil/2019/07/12/what-makes-for-a-successful-acquisition/
[14]https://hbr.org/2024/05/a-better-approach-to-mergers-and-acquisitions
