What is acquisition in accounting (with pros and cons)?

By Indeed Editorial Team

Published 22 June 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

In terms of business success, acquisition can be a crucial driver of overall corporate growth for an organisation and its assets. An acquisition can increase a small business' size, improve its market shares, help it diversify products and even transform it into a larger organisation. If you're interested in corporate finance, it's important to know everything you can about acquisition opportunities to make informed business decisions. In this article, we explore what acquisitions are and how they work, explain why they're important for business growth and look at their pros and cons.

What is acquisition?

If you're interested in a career where you get to help decide what a business can do to expand and grow, you may wonder what acquisition is. An acquisition is a term familiar to corporate finance and describes when one company buys most or all, of another existing company's assets and shares. The purpose of this transaction for the company making the acquisition is to gain control of the company they're buying.

Normally, an acquisition occurs when a larger company buys a smaller company, although that isn't always the case. Small companies can acquire larger companies, too. Here are some common features of acquisition:

  • Both companies continue to exist as separate legal entities. In an acquisition, one of the companies, the one buying the assets, becomes the parent company of the other.

  • Acquisition allows for more control. Purchasing more than 50% of a company's stock and other assets allows the acquirer to make decisions about the newly acquired assets.

  • In an acquisition, one company purchases another outright. There are other forms of transactions that can describe the consolidation of business assets including mergers, consolidations, purchase of assets, tender offers and management acquisition. Each have unique characteristics.

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4 Main types of acquisition

There are four general kinds of acquisition available for companies looking to expand their growth in this way. These include:

1. Vertical acquisition

A vertical acquisition takes place when one company integrates their supply chain with another to improve their efficiency and costs. A simple example is a bakery buying the source of the flour it uses, such as a farm. Acquiring suppliers and synchronising logistics and production helps businesses get access to components and materials. This is helpful when it's necessary for businesses to meet increasing demand and growth and acts as a way to increase market share by controlling access to supplies.

2. Horizontal acquisition

Horizontal acquisition takes place when a company acquires another company in the same business, usually a competitor. This happens quite frequently in the technology and software sector. A good example is when Facebook acquired Whatsapp and both experienced benefits from each other's expertise. Horizontal acquisition can expand a company's product range and increase revenue, improve its distribution coverage, increase market share and reduce competition.

3. Congeneric acquisition

A congeneric acquisition is when similar companies come together, such as those in a related industry or market, but which don't offer the same product. The companies may share things like production technology or distribution channels, making for an easier transition and integration of the two entities. Congeneric acquisitions may prove beneficial if an acquiring company gains the opportunity to expand its product line and grow their market share.

4. Conglomerate acquisition

Conglomerate acquisition happens when two companies join together but both operate in completely different types of business or industry. An example of conglomerate acquisition might be a grocery store that acquires a clothing business. This is usually done to diversify a business' range of products and expand their market.

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The difference between mergers vs acquisitions

Mergers and acquisitions sometimes get categorised together because they both involve the consolidation of two businesses. They're so closely linked that the term M&A (mergers and acquisitions) also refers to the desks at financial institutions that deal in such activity. But there are some important distinctions between these two terms that can help you expand your knowledge of acquisition. These differences include:

  • A merger occurs when two separate entities combine forces to create a new, joint organisation.

  • An acquisition refers to the takeover of one entity by another.

  • In a merger, both entities combine but only one continues to exist while the other company ceases.

  • Another form of business buying is amalgamation, where neither legal entity continues and an entirely new company begins.

Why acquisition is important for business growth

There are various reasons why acquisition is an important factor in business growth. Acquisition can help businesses grow in terms of scale, diversification, market share, synergy, cost reductions and niche markets. Here are a few reasons why acquisition helps businesses expand:

It helps businesses enter new markets

Acquisition can help businesses physically enter new markets. If a company is driven to expand their operations to another country, acquiring an existing company that's already established there is an easy way to enter this foreign market. The pre-existing, acquired business is already established in the country through their personnel and brand name, making it easier for the acquiring company to transition.

It helps business strategy

An acquisition can help a business' strategy by increasing the market share of their company quickly to gain a competitive edge in the marketplace. This is especially beneficial for companies that is facing logistic or physical setbacks or a lack of resources. Acquiring another business at this time is often more logical than trying to expand the one that already exists. Many businesses engage in acquisition with up-and-coming companies to enfold them into their overall profit strategy.

It helps decrease competition

Companies may choose to make acquisitions if there is a surplus of competition or supply within a market. By reducing the number of businesses operating through acquisition, this excess capacity disappears along with the competition. This allows for growth to occur for the most productive providers.

It helps businesses grow technologically

Acquisition can expand a company's technology in terms of hardware, software and human resources. Acquiring these assets is usually much more cost effective than strategising, planning and implementing brand new ones. Also, installing brand new technology and training staff to properly use it can take a large amount of time. Acquisition allows companies to rapidly acquire trained staff and technology that is already in place.

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How businesses acquire other businesses

For one business to acquire another, there are several steps that both parties go through to complete the process. These include:

  1. Making a plan. Businesses investigate the overall benefits of acquiring another company to develop an acquisition plan that gets the most while spending the least.

  2. Building a team. Once there is a plan in place, a business constructs an acquisition team usually consisting of a company executive, an investment banker, an acquisition lawyer, an HR expert, an IT specialist and a public relations officer.

  3. Researching the company. Gaining public information about the company to use when drafting a contract, touring its facilities and interviewing its executives all contribute to making an informed decision.

  4. Preparing essential documents. There are several necessary documents that you can draft for completion during the acquisition process, including a non-disclosure agreement, better of intent, confidential information memorandum, indication of interest and a purchase agreement.

  5. Making an offer. Once a company completes their preliminary research and gathering of documents, they can then initiate an acquisition by making an offer. The company attempting to buy the other makes the first offer in these instances.

  6. Negotiating terms. Once an offer is put forward, companies then settle on a price by either outright accepting the offer or engaging in a counteroffer.

  7. Writing and signing a contract. An acquisition is a complex process and many businesses hire contract lawyers to help negotiate terms. They also write up the legally binding contract that both companies sign to complete the acquisition.

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Pros and cons of acquisition

Acquiring a business is always risky to an extent and it's important to understand the pros and cons of acquisition before deciding to go through the process.

Pros

  • Access to experienced employees. When larger businesses acquire smaller businesses, they benefit from new financial, legal or human resource specialists.

  • New ideas and perspectives. Acquisitions bring like minded individuals and employees together to work on new, exciting challenges to help the business reach its goals.

  • Increased market share. Because acquisition lessens the competition within a market overall, the new company gains the combination of each firm's market share.

  • Synergy. When companies go through acquisition, reduced overhead is possible by eliminating redundant functions to improve profits.

Cons

  • Integration problems. Sometimes the two businesses that go through an acquisition have different cultural or operational expectations and climates that may affect the way the companies integrate.

  • Overestimating potential. Sometimes the calculated profit and risks associated with a particular acquisition can be poorly predicted, affecting long-term losses and gains.

  • Buying too high. The company that may potentially go through acquisition may naturally expect a high price for the transaction to be beneficial to them. When there is competition for the business, some companies may pay a higher price to complete the deal.

Please note that none of the companies mentioned in this article are affiliated with Indeed.

Related:

  • Most common types of mergers explained (with examples)


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