M&A Fundamentals

This is the first post on the "acquisition finance" series we started last week in MBA Mondays. I am going to try to lay out the basics of mergers and acquisitions in this post. Then we can move on to some details.

As the term M&A suggests, there are two types of deals, mergers and acquisitions. Acquisitions are way more common. It is when one company is taking control of the other. A merger is when two like sized businesses combine. An example of a merger is the AOL/Time Warner business combination ten years ago. I am not a fan of mergers. I believe it is way better when one company is taking control of the other. At least then you know who is in charge. Mergers are very complicated to pull off organizationally.

I have done a few mergers in the startup world. The best example is Return Path and Veripost which merged in 2002. The two companies started at about the same time, both got venture funding, and built almost identical businesses. They were beating each other up in the market and getting nowhere quickly. The management teams knew each other and the VCs (Brad Feld and yours truly) knew each other. We finally decided to put the two companies together in a merger. It worked because we decided that Matt Blumberg, Return Path's CEO, would run the combined companies and because Eric Kirby, Veripost's CEO, was fully supportive of that decision. Even so, it was not easy to execute.

Acquisitions are way more common and I believe way better. Most of the deals you can think of in startupland are acquisitions. A larger company is acquiring a smaller company and taking control of it.

The next distinction that matters a lot is how the consideration is paid. The most common forms of payment are cash and stock. In fact, you'll often hear corporate development people say "it's a stock deal" or "it's a cash deal." Companies can pay with other consideration as well. Debt is sometimes used as consideration, for example. But in startupland, you'll mostly see stock and cash.

Most people think cash is preferable. If you are selling your company, you want to know how much you are getting for it. And with cash, that is clear as crystal. With stock you are simply trading stock in your own company, which you control, for stock in someone else's company, which you don't control.

However, over the years in maybe a hundred deals now I have made more money in stock based deals with the acquirer's stock than I have lost in acquirer's stock. I don't know if that is just my good fortune or not. But I certainly have had the experience of taking stock in an acquisition and having that stock crumble and lose it all. So if you are doing a stock based deal, make sure you do your homework on the company and its stock.

The third and final distinction we will cover in this post is what the acquirer is purchasing. Typically the purchaser can either buy assets or buy the company (via its stock). If you are selling your company, you'll generally want to sell the entire company and thus all of its stock to the buyer. The buyer may not want to entire company and may suggest that it wants to do an "asset deal" which means it cherry picks what it wants and leaves you holding the bag on the unwanted assets and some or all of the liabilities.

For obvious reasons, fire sales are often done as asset deals. Healthy companies with bright futures are not often purchased in asset deals. They almost always sell the entire company in a stock deal. If you are selling your company you should try very hard to do a stock deal for the entire company.

That's it for this post. We've covered the three most important distinctions; merger or acquisition, paying with stock or cash, and buying assets or the entire business. We'll get into more detail on each of these issues and more in the coming weeks.