What Is an Acquisition?

Definition and Examples of Acquisitions

An acquisition occurs when one company purchases and takes over the operations and assets of another.

One example of this is when Amazon acquired Whole Foods in 2017 for approximately $13.7 billion.   

How Acquisitions Work

Acquisitions can be the amicable result of friendly discussions between two firms in which the target company welcomes the acquisition. In this situation, the two companies negotiate the terms of the acquisition and ultimately reach an agreement.

However, acquisitions can also occur against the will of the acquired firm’s management in what is called a “hostile takeover.” In a hostile takeover, an outside firm acquires a controlling interest in the target firm by purchasing more than 50% of the target company’s shares. This is done by offering the existing shareholders a higher price for their shares than what they could currently get on the open market, thereby enticing them to sell.

Regardless of whether the acquisition is friendly or hostile, the shares of the acquired firm are normally bought for more than their current market value. The difference between the current market price of a share and the price offered through a takeover is called the “premium.” When Amazon acquired Whole Foods in 2017, it offered $42 per share for Whole Foods, a 27% premium over its current share price.

Types of Acquisitions

An acquisition can be paid for in cash, through a security payment such as a stock-for-stock exchange, a leveraged buyout, or a combination of several of these methods.

A company can acquire another by giving cash to the existing shareholders of the target company for their shares. This is the simplest form of payment.

In a security payment, the acquiring company will offer new securities in exchange for the securities and assets of the target company.

Acquisitions vs. Mergers

The words “acquisition” and “merger” are often used interchangeably in practice, but the two are technically distinct. In an acquisition, the target company is folded into the acquiring company and ceases to exist. In a merger, two firms combine to form a new company.

Pros and Cons of Acquisitions

Acquisitions are motivated by a desire of the acquiring company to improve financial performance. However, as with any business activity, an acquisition is not without risk. There is no guarantee that an acquisition or merger will improve a company’s bottom line.

Pros Explained

• Economies of scale: Larger companies can buy material in bulk to streamline expenses as well as increase efficiency through specialization.
• Increased market share: If an acquisition combines two companies in the same industry, then the new company gains the combination of each firm’s market share.
• Vertical integration: Vertical integration occurs when a business buys another in its own supply chain.
• Synergy: When two firms merge, they can often reduce overhead by eliminating redundant functions. This expense reduction directly improves profitability.

Cons Explained

• Integration issues: If the cultural or operational climate isn’t compatible between the two firms, there may be problems integrating the two.
• Overestimating synergies: It takes time to combine two companies and integrate them into one cohesive firm. A transition time must occur before synergies are fully realized.
• Paying too much: The selling firm and its shareholders will naturally want the highest price they can get, and other parties involved in the transaction may be willing to pay more just to get the deal completed.