There are two ways a company can grow: One, by working organically and slowly ascending the market and two, by acquiring an existing company. Companies merge to increase their market share, and these transactions are Business Combinations. It is one of the most common ways of business expansion.
In upcoming sections, we have discussed business combination, its type, example, advantages and disadvantages in detail. It will give you a better insight into the acquisition process and the reasons for combinations.
Did you know? Asset acquisition is different from Business Combination. It is important that the asset acquired should constitute a business. Mere acquiring a group of assets will not be considered a Business combination.
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What is Business Combination?
The Business Combination definition states, “It is a transaction in which the acquirer obtains control of another business.” The acquirer takeover assets, liability and employees of the acquiree. Obtaining control is one of the key elements of the transaction. A company can acquire control of another company by either acquiring assets and liabilities or by acquiring significant equity. Let's see some examples in which an acquirer can obtain control.
- By buying net assets and paying in cash or cash equivalent
- By incurring liabilities
- By entering into a contract for taking over the management of the acquiree
- Or by acquiring more than 50% of equity shares of the acquiree.
Key Elements and Terms of Business Combinations
To better understand the meaning of business combination, it is important to know the key terms and elements of acquisition.
- Acquirer: The buyer company is taking over the business and control of another company.
- Control: It is the power to make significant management decisions, and the decision is related to the finance and operations of the business.
- Acquiree: It is the seller company whose net assets or equity interest is acquired by the acquirer.
- Business: It is one of the important elements. It is the group of activities and assets that can be individually managed and are capable of providing goods and services to the final customer, generating interest and dividends for the investors and other income. In simple words, an integrated system that is capable of carrying out ordinary business transactions.
- Asset acquisition: Under this scheme, buyers only take over certain assets and liabilities. The buyer doesn't get complete control of the entity, and it only assumes risk related to the purchased assets.
The Objectives of a Business Combination
- Market extension: Growing business organically is a slow process. Companies take over businesses of other entities working in the same industry but have a different market. The main objective is to increase the market share and client base.
- Product line expansion: To start a product line from scratch is a tedious and complicated process. Companies can merge with a company with the targeted product line. In such a combination, companies are saved from setting up things from scratch, and they acquire an existing business.
- Elimination of competition: Market leaders take over other entities to eliminate competition in the industry. Bringing companies under the same control is profitable and helps create a market monopoly.
- Effective management: Employees and expert managers are the assets of the company. Combining two or more companies also brings together the best management personnel. Under Business combinations transactions with assets and liabilities, employees and management are also taken over. Few mergers took place, especially to bring experts and experienced managers.
Different Types and Examples of Business Combinations
Every business combination transaction is different in terms and conditions, but they can be following major categories:
- Horizontal Business Combination: It is a transaction between two or more companies of the same industry. These companies operate in the same market and are each other's competitors. Such consolidation results in the elimination of competition and the extension of the market.
- For example, two companies working in the telecom industry, providing telecommunication and internet services to the population. The business combination among such companies is the Horizontal combination.
- A few real examples, In 2006, Disney acquired Pixar and Facebook's acquisition of Instagram.
- Vertical combinations: It is also known as process combination or sequence combination. Companies are operating at different levels. Its aim is to reduce the unnecessary cost of production and maintain the quality of the final product or services.
- For example, a cloth manufacturing company acquires a retail chain company. Both companies operate in different markets and cater to different processes. With this combination, the manufacturing company will not have to set up separate units for retail. This takeover benefits both companies as a retail chain company specialising in its work. It is like bringing good from both worlds.
- Lateral Combination: It is the combination of two businesses operating in different product lines, but at some level, they are relatable. There are the following types of lateral combinations.
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- Convergent: It is the combination of small units into one. Like different raw material suppliers will be combined to form one company. For example, a combination between a printing press and a paper mill.
- Divergent: It is the merger of related businesses. For example, a combination of Steel Mill with its dependent entities like a wire manufacturing company, tube manufacturing company etc.
- Diagonals: It is also known as manufacturing and service combination. Under this combination, a manufacturing company like a Phone company acquire a customer support company.
- Mixed Combinations: These combinations are between completely unrelated businesses. It is also known as a circular combination. For example, a ship manufacturing company combines with a real state company.
Business Combination Accounting
The entities are required to adopt the acquisition method for accounting. Under this method following steps are followed;
- Identify the acquirer
- Determine the acquisition date, and it is the date on which control is transferred to the acquirer.
- Recognise the assets taken over, liabilities assumed, and any non-controlling interest in the acquiree.
- Recognise and measure goodwill or gain on bargain purchases because of Business combination transactions.
The consolidated financial statements are prepared after business combinations. The acquirer prepares two sets of financial statements. Along with its statement, it prepares to combine the financial statement of the acquiree. The information included is post-acquisition. Anything related to the period before the acquisition will not form part of the consolidated financial statements.
Advantages of Business Combinations
- Competition: The major benefit of a business combination is the elimination of competition in the market.
- More customers: Combinations result in capturing new markets. This increased number of new customers will bring in more revenue.
- Low cost: The mergers help in achieving economies of scale. Large-scale production and the combination of best processes help in lowering per unit cost.
- Better management: It combines the best managerial personnel that provide benefits to the combined entity.
- Better services: By taking over a service company, the manufacturing company will be able to provide customer support services. That will provide increased customer satisfaction.
Disadvantages
- Monopoly: Business combination may result in the concentration of controlling power in the hands of a single company. The company can abuse this dominating power, which will not be good for the market and the customers in the long run.
- Added cost: To initiate a Business combination transaction and finalise it, a company hire experts, and it is a long and costly process.
- Uncertainty in employees: The takeover of a company creates uncertainty in the minds of the employees of the acquiree company. This might result in a hostile attitude from the labour force.
- It might fail: It is not guaranteed that every business combination will result in profit and gain.
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Conclusions
This was all about the business combination; with this article, you can better understand why companies opt for business combination and how it is advantageous. Business combination revolves around the concept of transaction where acquirers obtain control of another business. Business combinations is a common way for organisations to grow in size rather than organic activities.
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