The Legal Forms of Acquisitions
There are three basic legal procedures that one firm can use to acquire another firm:
1. Merger or consolidation.
2. Acquisition of stock.
3. Acquisition of assets
amalgamations Combinations of firms that have been joined by merger, consolidation, or
• acquiring firm as the bidder. This is the company that makes an offer to distribute cash or
securities to obtain the stock or assets of another company
• The firm that is sought (and perhaps acquired) is often called the target firm. The cash or
securities offered to the target firm are the consideration in the acquisition.
Merger or Consolidation
• merger The complete absorption of one company by another, where the acquiring firm
retains its identity and the acquired firm ceases to exist as a separate entity.
A merger refers to the complete absorption of one firm by another. The acquiring firm retains
its name and its identity, and it acquires all the assets and liabilities of the acquired firm. After
a merger, the acquired firm ceases to exist as a separate business entity.
consolidation A merger in which a new firm is created and both the acquired and acquiring firm
cease to exist.
• A consolidation is the same as a merger except that a new firm is created.
• In a consolidation, both the acquiring firm and the acquired firm terminate their previous
legal existence and become part of a new firm.
• For this reason, the distinction between the acquiring and the acquired firm is not as
important in a consolidation as it is in a merger
• The rules for mergers and consolidations are basically the same; Acquisition by merger
or consolidation results in a combination of the assets and liabilities of acquired and
acquiring firms; the only difference is whether or not a new firm is created. We henceforth
use the term merger to refer generically to both mergers and consolidations.
There are some advantages and some disadvantages to using a merger to acquire a firm:
• A primary advantage is that a merger is legally simple and does not cost as much as
other forms of acquisition. The reason is that the firms simply agree to combine their
entire operations. Thus, for example, there is no need to transfer title to individual assets
of the acquired firm to the acquiring firm.
• A primary disadvantage is that a merger must be approved by a vote of the shareholders of each firm. As we discuss later, obtaining majority assent is less of a problem in
Canada than in the United States because fewer Canadian corporations are widely held.
Typically, two-thirds (or even more) of the share votes are required for approval.
Obtaining the necessary votes can be time consuming and difficult. Furthermore, as we
later discuss in greater detail, the cooperation of the target firm's existing management is
almost a necessity for a merger. This cooperation may not be easily or cheaply obtained.
Acquisition of Stock
tender offer A public offer by one firm to directly buy the shares from another firm.
• This process often starts as a private offer from the management of one firm to another.
Regardless of how it starts, at some point the offer is taken directly to the target firm's
• This can be accomplished by a tender offer. A tender offer is a public offer to buy
shares. It is made by one firm directly to the shareholders of another firm.
• If the shareholders choose to accept the offer, they tender their shares by exchanging
them for cash or securities (or both), depending on the offer. A tender offer is frequently
contingent on the bidder's obtaining some percentage of the total voting shares. If not
enough shares are tendered, the offer might be withdrawn or reformulated.
circular bid Corporate takeover bid communicated to the shareholders by direct mail.
stock exchange bid Corporate takeover bid communicated to the shareholders through a stock
• The takeover bid is communicated to the target firm's shareholders by public
announcements such as newspaper advertisements.
• Takeover bids may be either by circular bid mailed directly to the target's shareholders
or by stock exchange bid (through the facilities of the TSX or other exchange).
• In either case, Ontario securities law requires that the bidder mail a notice of the
proposed share purchase to shareholders.
• Furthermore, the management of the target firm must also respond to the bid, including
their recommendation to accept or to reject the bid.
• For a circular bid, the response must be mailed to shareholders. If the bid is made
through a stock exchange, the response is through a press release.
The following factors are involved in choosing between an acquisition by stock and a merger:
1. In an acquisition by stock, no shareholder meetings have to be held and no vote
is required. If the shareholders of the target firm don't like the offer, they are not required
to accept it and need not tender their shares.
2. In an acquisition by stock, the bidding firm can deal directly with the shareholders
of the target firm by using a tender offer. The target firm's management and board of directors can be bypassed.
3. Acquisition by stock is occasionally unfriendly. In such cases, a stock acquisition
is used in an effort to circumvent the target firm's management, which is usually actively
resisting acquisition. Resistance by the target firm's management often makes the cost of
acquisition by stock higher than the cost of a merger.
4. Frequently, a significant minority of shareholders holds out in a tender offer. The
target firm cannot be completely absorbed when this happens, and this may delay
realization of the merger benefits or otherwise be costly.
Complete absorption of one firm by another requires a merger. Many acquisitions by stock end up
with a formal merger later.
1. Horizontal acquisition. This is acquisition of a firm in the same industry as the
bidder. The firms compete with each other in their product markets. A good example is
the acquisition of Alcan Inc. by Rio Tinto in 2007.
2. Vertical acquisition. A vertical acquisition involves firms at different steps of the
production process. The acquisition by an airline company of a travel agency would be a
vertical acquisition. For example, IBM's purchase of Cognos for $4.9 billion in 2007 was a
vertical merger. IBM is a computer technology and IT consulting corporation, while
Cognos provides software that companies use for data analysis.
3. Conglomerate acquisition. When the bidder and the target firm are not related to
each other, the merger is called a conglomerate acquisition. The acquisition of Federated
Department Stores by Campeau Corporation, a real estate company, was considered a
proxy contests Attempts to gain control of a firm by soliciting a sufficient number of shareholder
votes to replace existing management.
Takeovers can also occur with proxy contests. Proxy contests occur when a group
attempts to gain controlling seats on the board of directors by voting in new directors. A
proxy is the right to cast someone else's votes. In a proxy contest, proxies are solicited by
an unhappy group of shareholders from the rest of the shareholders.
going-private transactions All publicly owned stock in a firm is replaced with complete equity
ownership by a private group.
leveraged buyouts (LBOs) Going-private transactions in which a large percentage of the money
used to buy the stock is borrowed. Often, incumbent management is involved.
• In going-private transactions, all the equity shares of a public firm are purchased by a
small group of investors. Usually, the group includes members of incumbent
management and some outside investors.
• Such transactions have come to be known generically as leveraged buyouts (LBOs)
because a large percentage of the money needed to buy the stock is usually borrowed.
Such transactions are also termed MBOs (management buyouts) when existing
management is heavily involved. 3
Alternatives to Merger
strategic alliance Agreement between firms to cooperate in pursuit of a joint goal.
joint venture Typically an agreement between firms to create a separate, co-owned entity
established to pursue a joint goal. • Firms don't have to merge to combine their efforts. At a minimum, two (or more) firms can
simply agree to work together. They can sell each other's products, perhaps under
different brand names, or jointly develop a new product or technology.
• Firms will frequently establish a strategic alliance, which is usually a formal agreement
to cooperate in pursuit of a joint goal. An even more formal arrangement is a joint
venture, which commonly involves two firms putting up the money to establish a new
• For example, Saskatoon-based Shore Gold Inc. became an equal partner with dominant
De Beers Group in a joint venture to look for diamonds in a region just east of Prince
Taxes and Acquisitions
• In a taxable acquisition, the shareholders of the target firm are considered to have sold
their shares, and they have capital gains or losses that are taxed.
• In a tax-free acquisition, since the acquisition is considered an exchange instead of a
sale, no capital gain or loss occurs at that time.
• The general requirements for tax-free status; subject to corporate income tax and that
there be a continuity of equity interest
• In a tax-free acquisition, the selling shareholders are considered to have exchanged their
old shares for new ones of equal value, and no capital gains or losses are experience
• There are two factors to consider when comparing a tax-free acquisition and a taxable
acquisition: the capital gains effect and the write-up effect.
• The capital gains effect refers to the fact that the target firm's shareholders may have to
pay capital gains taxes in a taxable acquisition. They may demand a higher price as
compensation, thereby increasing the cost of the merger. This is a cost of taxable
• Assets of the selling firm are revalued or “written up” from their historic book value to their
estimated current market value. This is the write-up effect, and it is important because the
depreciation expense on the acquired firm's assets can be increased in taxable
acquisitions. Remember that an increase in depreciation is a non-cash expense, but it
has the desirable effect of reducing taxes.
Gains from Acquisition
Synergy The positive incremental net gain associated with the combination of two firms through
a merger or acquisi