What is it called when two or more companies come together to create a new company?

If you listen to the news or pay attention to business, you are aware of the �merger mania� that has been occurring in the U.S. over the past decade. What exactly is a merger and how does it differ from an acquisition? The details can become overwhelming, but we will try to come up with some basic definitions and discuss some general ideas.

Merger: When two companies combine to form one new company. There is nothing left of the combining companies.

Acquisition: When one company buys another and it becomes part of the buying organization.

There are other forms of business combinations, such as joint ventures, and consortia.

A joint venture is when two or more separate companies form a third business that is controlled and owned by the others (called the parent organizations).

A consortium is when many companies pool their resources to solve one problem. For example, many pharmaceutical companies may put their money together to work on an R&D project that provides all the companies with the results.

Why do mergers and acquisitions (M&A) occur?

The big reason these business combinations occur is because companies are looking to control uncertainty. Can you think of some areas of uncertainty that can be reduced through a merger or acquisition? Think about where companies get their supplies, where their competition comes from, and how they can reduce the effects of an ailing business.

For example, if a company wants to make sure that its source of supplies is guaranteed (as much as possible) to them rather than competitors, they can buy it. This is called vertical integration; a company tries to control the vertical process of its business. If we make tires and want to make sure that our supply of rubber is there when we need it, we can buy a rubber manufacturing company. This would be vertical integration. Another example of vertical integration is controlling the distribution process of our company. Using the same tire example, we would this time buy the retail or wholesale companies that sell our products. Or if we don�t have our own shipping fleet, we would get one.

Can you think of examples for the other two suggestions? Which one is horizontal integration?

How is the government involved in M&A?

One way that government becomes involved in M&A is through antitrust laws.

Antitrust Laws: The Sherman Act was established in 1890, which was the first national antitrust law to regulate monopoly and monopoly power. Other similar laws, such as the Clayton Act, followed over time. Antitrust laws are designed to promote competition. AT&T was broken up into the Baby Bells under antitrust legislation. Many large-scale mergers and acquisitions are reviewed and sometimes stopped under antitrust laws. Antitrust laws also prohibit any type of inter-company agreements that promote monopoly power.

In essence, anytime a merger or acquisition has the opportunity of decreasing competition, the government steps in and stops it. Can you think of an example of a recent merger that was stopped by the government? Why do you think it was stopped?

Different types of M&A in the corporate world

What is a Merger?

A merger refers to an agreement in which two companies join together to form one company. In other words, a merger is the combination of two companies into a single legal entity. In this article, we will look at different types of mergers that companies can undergo.

What is it called when two or more companies come together to create a new company?

Types of Mergers

There are five basic categories or types of mergers:

  1. Horizontal merger: A merger between companies that are in direct competition with each other in terms of product lines and markets
  2. Vertical merger: A merger between companies that are along the same supply chain (e.g., a retail company in the auto parts industry merges with a company that supplies raw materials for auto parts.)
  3. Market-extension merger: A merger between companies in different markets that sell similar products or services
  4. Product-extension merger: A merger between companies in the same markets that sell different but related products or services
  5. Conglomerate merger: A merger between companies in unrelated business activities (e.g., a  clothing company buys a software company)

Learn about modeling different types of mergers in CFI’s M&A Financial Modeling Course.

Horizontal Mergers

A horizontal merger is a merger between companies that directly compete with each other. Horizontal mergers are done to increase market power (market share), further utilize economies of scale, and exploit merger synergies.

A famous example of a horizontal merger was that between HP (Hewlett-Packard) and Compaq in 2011. The successful merger between these two companies created a global technology leader valued at over US$87 billion.

What is it called when two or more companies come together to create a new company?

Vertical Mergers

A vertical merger is a merger between companies that operate along the same supply chain. A vertical merger is the combination of companies along the production and distribution process of a business. The rationale behind a vertical merger includes higher quality control, better flow of information along the supply chain, and merger synergies.

A notable vertical merger happened between America Online and Time Warner in 2000. The merger was considered a vertical merger due to each company’s different operations in the supply chain – Time Warner supplied information through CNN and Time Magazine while AOL distributed information through the internet.

What is it called when two or more companies come together to create a new company?

Market-Extension Mergers

A market-extension merger is a merger between companies that sell the same products or services but that operate in different markets. The goal of a market-extension merger is to gain access to a larger market and thus a bigger client/customer base.

For example, RBC Centura’s merger with Eagle Bancshares Inc. in 2002 was a market-extension merger that helped RBC with its growing operations in the North American market. Eagle Bancshares owned Tucker Federal Bank, one of the biggest banks in Atlanta, with over 250 workers and $1.1 billion in assets.

What is it called when two or more companies come together to create a new company?

Learn about modeling different types of mergers in CFI’s M&A Financial Modeling Course.

Product-Extension Mergers

A product-extension merger is a merger between companies that sell related products or services and that operate in the same market. By employing a product-extension merger, the merged company is able to group their products together and gain access to more consumers. It is important to note that the products and services of both companies are not the same, but they are related. The key is that they utilize similar distribution channels and common, or related, production processions or supply chains.

For example, the merger between Mobilink Telecom Inc. and Broadcom is a product-extension merger. The two companies both operate in the electronics industry and the resulting merger allowed the companies to combine technologies. The merger enabled the combination of Mobilink’s 2G and 2.5G technologies with Broadcom’s 802.11, Bluetooth, and DSP products. Therefore, the two companies are able to sell products that complement each other.

What is it called when two or more companies come together to create a new company?

Learn about modeling different types of mergers in CFI’s M&A Financial Modeling Course.

Conglomerate Mergers

A conglomerate merger is a merger between companies that are totally unrelated. There are two types of a conglomerate merger: pure and mixed.

  • A pure conglomerate merger involves companies that are totally unrelated and that operate in distinct markets.
  • A mixed conglomerate merger involves companies that are looking to expand product lines or target markets.

The biggest risk in a conglomerate merger is the immediate shift in business operations resulting from the merger, as the two companies operate in completely different markets and offer unrelated products/services.

For example, the merger between Walt Disney Company and the American Broadcasting Company (ABC) was a conglomerate merger. Walt Disney Company is an entertainment company, while American Broadcasting company is a US commercial broadcast television network (media and news company).

What is it called when two or more companies come together to create a new company?

More Resources

Thank you for reading CFI’s guide to Types of Mergers. To learn more and expand your career, explore the additional relevant CFI resources below:

  • Amalgamation
  • Consolidation Method
  • Mergers and Acquisition Process
  • Merger Consequences Analysis

What is it called when two companies come together?

A company merger is when two companies combine to form a new company. Companies merge to expand their market share, diversify products, reduce risk and competition, and increase profits.

What is it called when two or more businesses become one business?

A merger takes place when two or more businesses want to join forces and become a single entity.