Acquisitions – Definition

Definition of acquisitions: Where a company or organisation gains control and ownership of a company, trade, or a collection of specific assets and liabilities.

What is an acquisition?

An acquisition involves an asset changing hands between two parties. Acquisitions are also known as ‘buy-outs’, ‘takeovers’ and ‘strategic investments’.

Acquisitions can take quite distinct legal forms, yet appear to look very similar when described in press releases or the financial press.

Let’s explore the major categories of acquisition:

1. Acquisition of shares in a company

If an acquirer purchases all of the voting shares in a companies capital structure, this will give them full control over the company.

Where the acquirer is a company, it will become a parent or holding company. The purchased company will become a subsidiary in the organisational structure terms, within the group of companies.

If the acquirer is an individual, then they will become a shareholder of the acquired business and will be able to directly vote on shareholder resolutions at the Annual General Meeting (AGM) of shareholders.

After gaining full control of a company, an owner can:

  • Buy or sell the companies assets
  • Appoint or terminate the board of directors, such as the CEO who ultimately runs the company.

Where there is only one shareholder, the board of directors will govern and manage the firm in accordance with the wishes of the shareholder. Therefore it is the ability to appoint the board which provides the power and control over a company’s affairs.

2. Acquisition of trade

Sometimes an acquirer doesn’t wish to purchase an entire company.

The company might carry on trade in different products & markets which are of little interest to the buyer.

Therefore, a Sale and Purchase Agreement (SPA) may be drawn up which specifically outlines which aspects of the company are being sold. This will typically include ‘trade’. But what is trade?

Trade represents the ability of the company to continue its activities to source, produce and sell goods and services. It will likely include the trading name or brand which the company uses to trade, and all of the employees who are directly involved in that trade currently.

In summary, acquiring trade is essentially buying all the individual components which are needed for a business unit to operate as a separate entity.

For a retailer, this might include:

  • The brand name
  • The leases for retail units
  • Sales staff
  • Purchase agreements with suppliers
  • A warehouse where goods are stored
  • Vehicles used to supply the stores

A SPA needs to very clearly define which employees, assets and liabilities and trade are included in the purchase. This will allow the accountants and lawyers to ensure that the general ledger reflects the transfer of these items out of one company and into another.

In the financial statements, the seller will usually highlight any sold trade as a ‘discontinued operation’ in accordance with IFRS.

Liabilities and obligations may also be transferred as part of the sale. These will reduce the transaction price, as they will result in an outflow of cash from the acquirer at a later date. Examples may include tax liabilities, unpaid payroll costs and unpaid supplier invoices.

Acquisitions - Definition
The definition of acquisitions is a finance concept

3. Acquisition of individual assets

The simplest type of acquisition is where the acquirer purchases a simple list of assets.

In legal and accounting terms, this isn’t too different to any purchase of a business, be it for inventory or services in the course of ordinary trade.

Examples might be:

  • The acquisition of a store/location from a competitor
  • The purchase of unsold stock from a company which has entered liquidation.
  • A football team buying out the contract of a football player to allow them to join the new club.

These are straightforward to account for, as it is easy to see the price paid for each item.

Why do companies make corporate acquisitions?

Acquisitions are common, and bring a variety of strategic benefits to the acquirer. Let’s explore some of the key incentives for businesses to acquire other businesses:

Synergy – A larger company can usually eliminate the overheads of the incoming business by using their existing administrative departments to perform the same tasks. This means that a single, larger company will generate more profit than the sum of two smaller companies. This principle is known as synergy.

To diversify their operations – Companies may acquire competitors in other geographic locations, or complementary businesses in the same market, in order to quickly gain a new revenue stream. Having multiple markets can protect turnover during volatile periods.

To expand their offering – Companies spend a lot of resources acquiring new customers. But once a customer relationship is started, it’s much easier to sell more products to that customer, than seeking out another customer. Take for example the range of existing sky customer deals offered just to allow Sky to retain its existing base.

For this reason, companies like to expand their offerings to cater to many of their customer needs, which allows them to maximise their revenue with the minimum in sales & marketing effort.

To edge closer to monopoly status – many acquisitions occur as a defensive measure to reduce competition and stifle the free market. This is seen frequently in the tech sector, where start-ups with innovative and disruptive ideas are acquired by deep-pocketed tech conglomerates. This protects the acquirer from having to compete with an evolved & mature version of the start-up in the future.

How does the definition of acquisitions relate to investing?

Acquisitions are a high-profile piece of financial news which often moves share prices significantly.

When a public company is the subject of a take-over, the price of the companies shares will move towards the market’s expectation of what the acquirer would be willing to pay to buy the whole company and ‘take it private’.

Acquirers must always offer a premium price to the current share price, in order to stand a chance at convincing even the more stubborn shareholders to sell. (After all, the market price of a share represents the lowest price that any shareholder is prepared to sell for, so is very reflective of the price needed to convince the majority of shareholders to sell).

This means that the share price of a potential acquisition target will jump sharply when interest from an acquirer is announced.

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