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Acquisition

Definition of Acquisition

The acquisition is a form of business combination which is a method of Inter-corporate investments; IFRS doesn’t distinguish between various forms of business combinations, but US GAAP does, and according to the same, there is an acquiring company and a target company, and post-acquisition, both the companies exist. Still, only the acquiring company reports the consolidated balance financial statement, including the results of the target company.

Explanation of Acquisition

Under US GAAP, there are four kinds of business combinations:

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  1. A merger implies that the target company ceases to exist post-merger while only the acquiring company exists, and in most cases, post-merger becomes a more significant entity.
  2. It implies that both the target & the acquiring companies continue to exist post-acquisition, and the acquiring company reports consolidated and standalone financial statements. In contrast, the target company only reports standalone financial statements.
  3. Consolidation implies that both the target & the acquiring companies cease to exist post-consolidation, and a new entity is formed by combining the assets & liabilities of both companies.
  4. SPV: Special purpose vehicle is another form of the business combination, but the usage of this form is mostly to spin off the portions of a company or improve the balance sheet; therefore, it is not truly a business combination. At times it is also known as the Variable Interest Entity.

Characteristics of Acquisition

Following are the characteristics given below:

Characteristics of Acquisition

  • Parties Involved: There are two parties to an acquisition transaction: the acquirer and the target company.
  • Percentage of Acquisition: As with most business combinations, the percentage should be at least 50% or more for a transaction to be categorized as an acquisition. At times, there are transactions termed as acquisitions with even less than 50% interest but significant controlling influence, and therefore, this rule is bent slightly.
  • Control: In a business combination, the investment gives the acquirer a controlling interest. The acquiring company can make decisions as to the policies of the target company, such as the dividend policy and so on. In other forms of inter-corporate investments, such as the investment in associates or financial assets, the amount of influence is lower or significant but not controlled.
  • Method of Accounting: The method of accounting used for all business combination transactions under both IFRS and US GAAP is known as the ‘Acquisition’ method.
  • Minority Interest: When the acquisition is of less than 100% of the target company, the minority interest is shown on the consolidated balance sheet of the acquiring company, as per the guidelines of IFRS or US GAAP, which differ in accounting methods of goodwill.

Example of Acquisition

In 2011, Google acquired Motorola Mobility, but both companies existed to port the acquisition. Motorola operated as an independent entity post-acquisition. The main aim of this was to develop the patents owned by Motorola and prevent the misuse of Google’s Android software.

Google had significant control over Motorola, wherein it could change key personnel, sell off parts of the company to various entities,  and once all the purposes for which it had acquired the company, Google sold it off to Lenovo after owning it for 2-3 years.

This deal involved the payment to the Motorola shareholders in cash, which meant that Google didn’t want to dilute its control after the acquisition so that it could take the hard decisions without much resistance from the Motorola shareholders.

Types of Acquisition

Types are classified based on the nature of the businesses the two companies are in:

Types of Acquisition

1. Horizontal: It is when a company acquires another company in the same business that is a competitor. For example, one telecom company is acquiring another.

2. Vertical: It is when a company acquires either a supplier of inputs or a distributor of its products or the company to which it sells its products—for example, a garment company acquiring the source of cotton, such as a farm.

3. Conglomerate: It is when a company acquires a company in a completely different kind of business. This is mainly done for diversification. An example of this would be a food industry company acquiring a company in the clothing industry.

Difference Between Acquisition & Merger

In a merger, the target company is dissolved and doesn’t exist at all. All its assets and liabilities are added to the acquiring company’s balance sheet, which becomes more prominent in size and operations as an outcome of such a combination. In this, both the Target and the acquirer continue to exist post-acquisition.

As the target company is dissolved, there is no other form of a financial statement than the consolidated ones in a merger transaction. Both companies exist in the transaction, so both publish their standalone financial statements, and the acquirer also publishes the consolidated financial statements.

Benefits

  • Both companies exist; therefore, there is a higher chance of a smoother amalgamation of both companies’ work cultures and best practices.
  • Companies with expertise in their field continue to do the same; therefore, there is a lower chance of work disruption.
  • Added facilities lead to more excellent synchronization of related activities, such as having an in-house courier partner is beneficial for an eCommerce company because it can have greater control over the delivery aspect of its work. Further, it doesn’t have to depend on the inefficiencies of a third-party courier company.

Disadvantages

  • From the perspective of costs, the acquisition is more expensive than outsourcing because the fixed expenses need to be borne by the acquiring company. In periods of slowdown, these become a significant burden on profitability. Also, the acquirer has to pay the existing shareholders of the target company a premium over the stock’s market value so that they agree to the acquisition.
  • Loss of control of the target company occurs; therefore, the acquirer’s decisions may not favor the target company, and it might not be able to do much about the same.

Conclusion

Therefore, we understand that the acquisition is a business combination under the US GAAP classification, while under IFRS, no such distinction is made. Post-acquisition, both entities exist, but the acquirer has significant control over the decision-making and the assets and liabilities of the target company. It is widespread in present times, but they differ from mergers because, as an outcome of the merger, the target company ceases to exist, which is not the case in an acquisition.

Recommended Articles

This is a guide to acquisition. Here we also discuss the introduction to acquisition along with its characteristics, benefits, and disadvantages. You may also have a look at the following articles to learn more –

  1. Acquisition Examples
  2. Customer Acquisition Strategy
  3. Cross Border Merger and Acquisitions
  4. Return on Investment Ratio
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