An entrepreneur may grow its business
either by internal expansion or by external expansion. In the case of internal
expansion, a firm grows gradually over time in the normal course of the
business, through acquisition of new assets, replacement of the technologically
obsolete equipments and the establishment of new lines of products. But
in external expansion, a firm acquires a running business and grows overnight
through corporate combinations. These combinations are in the form of
mergers, acquisitions, amalgamations and takeovers and have now become
important features of corporate restructuring. They have been playing
an important role in the external growth of a number of leading companies
the world over. They have become popular because of the enhanced competition,
breaking of trade barriers, free flow of capital across countries and
globalisation of businesses. In the wake of economic reforms, Indian industries
have also started restructuring their operations around their core business
activities through acquisition and takeovers because of their increasing
exposure to competition both domestically and internationally.
Mergers and acquisitions are strategic
decisions taken for maximisation of a company's growth by enhancing its
production and marketing operations. They are being used in a wide array
of fields such as information technology, telecommunications, and business
process outsourcing as well as in traditional businesses in order to gain
strength, expand the customer base, cut competition or enter into a new
market or product segment.
Mergers or Amalgamations
A merger is a combination of two or
more businesses into one business. Laws in India use the term 'amalgamation'
for merger. The Income
Tax Act,1961 [Section 2(1A)] defines amalgamation as the merger of
one or more companies with another or the merger of two or more companies
to form a new company, in such a way that all assets and liabilities of
the amalgamating companies become assets and liabilities of the amalgamated
company and shareholders not less than nine-tenths in value of the shares
in the amalgamating company or companies become shareholders of the amalgamated
Thus, mergers or amalgamations may take
- Merger through Absorption:- An absorption
is a combination of two or more companies into an 'existing company'.
All companies except one lose their identity in such a merger. For example,
absorption of Tata Fertilisers Ltd (TFL) by Tata Chemicals Ltd. (TCL).
TCL, an acquiring company (a buyer), survived after merger while TFL,
an acquired company (a seller), ceased to exist. TFL transferred its
assets, liabilities and shares to TCL.
- Merger through Consolidation:- A consolidation
is a combination of two or more companies into a 'new company'. In this
form of merger, all companies are legally dissolved and a new entity
is created. Here, the acquired company transfers its assets, liabilities
and shares to the acquiring company for cash or exchange of shares.
For example, merger of Hindustan Computers Ltd, Hindustan Instruments
Ltd, Indian Software Company Ltd and Indian Reprographics Ltd into an
entirely new company called HCL Ltd.
A fundamental characteristic of merger
(either through absorption or consolidation) is that the acquiring company
(existing or new) takes over the ownership of other companies and combines
their operations with its own operations.
Besides, there are three major types
- Horizontal merger:- is a combination
of two or more firms in the same area of business. For example, combining
of two book publishers or two luggage manufacturing companies to gain
dominant market share.
- Vertical merger:- is a combination
of two or more firms involved in different stages of production or distribution
of the same product. For example, joining of a TV manufacturing(assembling)
company and a TV marketing company or joining of a spinning company
and a weaving company. Vertical merger may take the form of forward
or backward merger. When a company combines with the supplier of material,
it is called backward merger and when it combines with the customer,
it is known as forward merger.
- Conglomerate merger:- is a combination
of firms engaged in unrelated lines of business activity. For example,
merging of different businesses like manufacturing of cement products,
fertilizer products, electronic products, insurance investment and advertising
agencies. L&T and Voltas Ltd are examples of such mergers.
Acquisitions and Takeovers
An acquisition may be defined as an
act of acquiring effective control by one company over assets or management
of another company without any combination of companies. Thus, in an acquisition
two or more companies may remain independent, separate legal entities,
but there may be a change in control of the companies. When an acquisition
is 'forced' or 'unwilling', it is called a takeover. In an unwilling acquisition,
the management of 'target' company would oppose a move of being taken
over. But, when managements of acquiring and target companies mutually
and willingly agree for the takeover, it is called acquisition or friendly
Monopolies and Restrictive Practices Act, takeover meant acquisition
of not less than 25 percent of the voting power in a company. While in the
Companies Act (Section 372), a company's investment in the shares
of another company in excess of 10 percent of the subscribed capital can
result in takeovers. An acquisition or takeover does not necessarily entail
full legal control. A company can also have effective control over another
company by holding a minority ownership.
Advantages of Mergers &
The most common motives and advantages
of mergers and acquisitions are:-
- Accelerating a company's growth, particularly
when its internal growth is constrained due to paucity of resources.
Internal growth requires that a company should develop its operating
facilities- manufacturing, research, marketing, etc. But, lack or inadequacy
of resources and time needed for internal development may constrain
a company's pace of growth. Hence, a company can acquire production
facilities as well as other resources from outside through mergers and
acquisitions. Specially, for entering in new products/markets, the company
may lack technical skills and may require special marketing skills and
a wide distribution network to access different segments of markets.
The company can acquire existing company or companies with requisite
infrastructure and skills and grow quickly.
- Enhancing profitability because a
combination of two or more companies may result in more than average
profitability due to cost reduction and efficient utilization of resources.
This may happen because of:-
- Economies of scale:- arise when
increase in the volume of production leads to a reduction in the cost
of production per unit. This is because, with merger, fixed costs
are distributed over a large volume of production causing the unit
cost of production to decline. Economies of scale may also arise from
other indivisibilities such as production facilities, management functions
and management resources and systems. This is because a given function,
facility or resource is utilized for a large scale of operations by
the combined firm.
- Operating economies:- arise because,
a combination of two or more firms may result in cost reduction due
to operating economies. In other words, a combined firm may avoid
or reduce over-lapping functions and consolidate its management functions
such as manufacturing, marketing, R&D and thus reduce operating
costs. For example, a combined firm may eliminate duplicate channels
of distribution, or crate a centralized training center, or introduce
an integrated planning and control system.
- Synergy:- implies a situation where
the combined firm is more valuable than the sum of the individual
combining firms. It refers to benefits other than those related to
economies of scale. Operating economies are one form of synergy benefits.
But apart from operating economies, synergy may also arise from enhanced
managerial capabilities, creativity, innovativeness, R&D and market
coverage capacity due to the complementarity of resources and skills
and a widened horizon of opportunities.
- Diversifying the risks of the company,
particularly when it acquires those businesses whose income streams
are not correlated. Diversification implies growth through the combination
of firms in unrelated businesses. It results in reduction of total risks
through substantial reduction of cyclicality of operations. The combination
of management and other systems strengthen the capacity of the combined
firm to withstand the severity of the unforeseen economic factors which
could otherwise endanger the survival of the individual companies.
- A merger may result in financial synergy
and benefits for the firm in many ways:-
- By eliminating financial
- By enhancing debt capacity. This is because a merger
of two companies can bring stability of cash flows which in turn reduces
the risk of insolvency and enhances the capacity of the new entity to
service a larger amount of debt
- By lowering the financial costs.
This is because due to financial stability, the merged firm is able
to borrow at a lower rate of interest.
- Limiting the severity of competition
by increasing the company's market power. A merger can increase the
market share of the merged firm. This improves the profitability of
the firm due to economies of scale. The bargaining power of the firm
vis-à-vis labour, suppliers and buyers is also enhanced. The
merged firm can exploit technological breakthroughs against obsolescence
and price wars.
Procedure for evaluating the decision for mergers and acquisitions
The three important steps involved in
the analysis of mergers and acquisitions are:-
- Planning:- of acquisition will require
the analysis of industry-specific and firm-specific information. The
acquiring firm should review its objective of acquisition in the context
of its strengths and weaknesses and corporate goals. It will need industry
data on market growth, nature of competition, ease of entry, capital
and labour intensity, degree of regulation, etc. This will help in indicating
the product-market strategies that are appropriate for the company.
It will also help the firm in identifying the business units that should
be dropped or added. On the other hand, the target firm will need information
about quality of management, market share and size, capital structure,
profitability, production and marketing capabilities, etc.
- Search and Screening:- Search focuses
on how and where to look for suitable candidates for acquisition. Screening
process short-lists a few candidates from many available and obtains
detailed information about each of them.
- Financial Evaluation:- of a merger
is needed to determine the earnings and cash flows, areas of risk, the
maximum price payable to the target company and the best way to finance
the merger. In a competitive market situation, the current market value
is the correct and fair value of the share of the target firm. The target
firm will not accept any offer below the current market value of its
share. The target firm may, in fact, expect the offer price to be more
than the current market value of its share since it may expect that
merger benefits will accrue to the acquiring firm.
A merger is said to be at a premium
when the offer price is higher than the target firm's pre-merger market
value. The acquiring firm may have to pay premium as an incentive to
target firm's shareholders to induce them to sell their shares so that
it (acquiring firm) is able to obtain the control of the target firm.
Regulations for Mergers & Acquisitions
Mergers and acquisitions are regulated
under various laws in India. The objective of the laws is to make these
deals transparent and protect the interest of all shareholders. They are
regulated through the provisions of :-
Companies Act, 1956
The Act lays down the legal procedures
for mergers or acquisitions :-
- Permission for merger:- Two or
more companies can amalgamate only when the amalgamation is permitted
under their memorandum of association. Also, the acquiring company
should have the permission in its object clause to carry on the business
of the acquired company. In the absence of these provisions in the
memorandum of association, it is necessary to seek the permission
of the shareholders, board of directors and the Company Law Board
before affecting the merger.
- Information to the stock exchange:- The acquiring and the acquired companies should inform the stock exchanges
(where they are listed) about the merger.
- Approval of board of directors:- The board of directors of the individual companies should approve
the draft proposal for amalgamation and authorise the managements
of the companies to further pursue the proposal.
- Application in the High Court:- An application for approving the draft amalgamation proposal duly
approved by the board of directors of the individual companies should
be made to the High Court.
- Shareholders' and creators' meetings:- The individual companies should hold separate meetings of their shareholders
and creditors for approving the amalgamation scheme. At least, 75 percent
of shareholders and creditors in separate meeting, voting in person
or by proxy, must accord their approval to the scheme.
- Sanction by the High Court:- After
the approval of the shareholders and creditors, on the petitions of
the companies, the High Court will pass an order, sanctioning the
amalgamation scheme after it is satisfied that the scheme is fair
and reasonable. The date of the court's hearing will be published
in two newspapers, and also, the regional director of the Company
Law Board will be intimated.
- Filing of the Court order:- After
the Court order, its certified true copies will be filed with the
Registrar of Companies.
- Transfer of assets and liabilities:- The assets and liabilities of the acquired company will be transferred
to the acquiring company in accordance with the approved scheme, with
effect from the specified date.
- Payment by cash or securities:- As per the proposal, the acquiring company will exchange shares and
debentures and/or cash for the shares and debentures of the acquired
company. These securities will be listed on the stock exchange.
Competition Act, 2002
The Act regulates the various forms
combinations through Competition
Commission of India. Under the Act, no person or enterprise shall
enter into a combination, in the form of an acquisition, merger or amalgamation,
which causes or is likely to cause an appreciable adverse effect on
competition in the relevant market and such a combination shall be void.
Enterprises intending to enter into a combination may give notice to
the Commission, but this notification is voluntary. But, all combinations
do not call for scrutiny unless the resulting combination exceeds the
threshold limits in terms of assets or turnover as specified by the
Competition Commission of India. The Commission while regulating a 'combination'
shall consider the following factors :-
- Actual and potential competition
- Extent of entry barriers into the
- Level of combination in the market;
- Degree of countervailing power
in the market;
- Possibility of the combination
to significantly and substantially increase prices or profits;
- Extent of effective competition
likely to sustain in a market;
- Availability of substitutes before
and after the combination;
- Market share of the parties to
the combination individually and as a combination;
- Possibility of the combination
to remove the vigorous and effective competitor or competition in
- Nature and extent of vertical integration
in the market;
- Nature and extent of innovation;
- Whether the benefits of the combinations
outweigh the adverse impact of the combination.
Thus, the Competition Act does not
seek to eliminate combinations and only aims to eliminate their harmful
- The other regulations are provided
in the:- The
Foreign Exchange Management Act, 1999 and the
Income Tax Act,1961. Besides, the Securities
and Exchange Board of India (SEBI) has issued guidelines to regulate
mergers and acquisitions. The SEBI
(Substantial Acquisition of Shares and Take-overs) Regulations,1997 and its subsequent amendments aim at making the take-over process transparent,
and also protect the interests of minority shareholders.