External expansion refers to business combination where two or more concerns combines and expand their business activities. The ownership and control of the combined concerns may be undertaken by a single agency.
Business combination is a method of economic organization by which a common control, of greater or lesser completeness is exercised over a number of firms which either is operating in competition or independently. This control may either be temporary or permanent, for all or only for some purposes. This control over the combining firm can be exercised by a number of methods which in turn give rise to various forms of combinations.
In the process of combination, two or more units engage in similar business or in different related process or sages of the same business join with a view to carry on their activities or shape or shape their polices on common or coordinated basis for mutual benefit or maximum profits. The combination may be among competing units or units engaged in different processes. After combination, the constituted firm pursues some common objectives or goals.
Forms of combination
There is some disagreement on the precise meaning of various terms relating to the forms of business combinations, viz; merger, amalgamation, absorption, consolidation, acquisition, takeover, etc. sometimes, these terms are used interchangeably, in a broader sense even when there are legal distinctions between the kinds of combinations.
1. Merger or Amalgamation
In business or economics a merger is a combination of two companies into one larger company. It may be in the form of one or more companies being merged into an existing company or a new company may be formed to merge two or more existing companies. Such actions are commonly voluntary and involve stock swap or cash payment to the target. Stock swap is often used as it allows the shareholders of the two companies to share the risk involved in the deal. A merger can resemble a takeover but result in a new company name (often combining the names of the original companies) and in new branding; in some cases, terming the combination a “merger” rather than an acquisition is done purely for political or marketing reasons.
Merger is a financial tool that is used for enhancing long-term profitability by expanding their operations. Mergers occur when the merging companies have their mutual consent. The income tax Act, 1961 of India uses the term ‘amalgamation’ for merger.
According to companies act, 1956, the term amalgamation includes ‘absorption’. In SS Somayajula v. Hop Prudhommee and co. ltd. The learned judge refers to amalgamation as “a state of things under which either two companies are joined so as to form a third entity or one is absorbed into or blend with another”.
- Merger or amalgamation through absorption.
- Merger or amalgamation through consolidation.
Absorption. A combination of two or more companies into an existing company is known as ‘absorption’. In absorption all companies expect one go into liquidation and lose their separate identities. E.g. Absorption of Reliance Polyproplene Ltd. (RPPL) by Reliance Industries Ltd. As a result of the absorption, the RPPL was liquidated and its shareholders were offered 20 shares of RIL for every 100 shares of RPPL held by them.
Consolidation. A consolidation is a combination of two or more companies into a new company. In this form of merge, all the existing companies, which combine, go into a new company. In this form of merger, all the existing companies, which combine, go into liquidation and form a new company with a different entity. The entity of the existing company is lost and their assets and liabilities are taking over by the new corporation or company. The assets of old concern are sold to a new concern and their management and control also passes into the hands of the new concern.eg. there are two companies called A ltd. and B Ltd. and they merge together to form a new company called AB Ltd. or C Ltd. it is a case of consolidation . The term consolidation is also sometimes used as amalgamation.
Types of Mergers
From the perspective of business structures, there is a whole host of different mergers. Here are a few types, distinguished by the relationship between the two companies that are merging:
- Horizontal merger – Two companies that are in direct competition and share similar product lines and markets, join together it is known as a horizontal merger. The idea behind this type of merger is to avoid competition between the units. (e.g.: two manufacturers’ of same type of cloth, two transport companies operating on the same route-the merger in all these cases will be horizontal merger.
- Vertical merger – A customer and company or a supplier and company. (e.g.: an ice cream maker merges with the dairy farm that they previously purchased milk from; now, the milk is ‘free’)
- Market-extension merger – Two companies that sell the same products in different markets (e.g.: an ice cream maker in the United States merges with an ice cream maker in Canada)
- Product-extension merger – Two companies selling different but related products in the same market (e.g a cone supplier merging with an ice cream maker).
- Conglomeration – Two companies that have no common business areas where two merging firms are in the same general industry, but they have no mutual buyer/customer or supplier relationship, such as a merger between a bank and a leasing company. Example: Prudential’s acquisition of Bache & Company.
2. Acquisitions or Take-Over
An acquisition, also known as a takeover or a buyout, is the buying of one company by another. It is an act of acquiring control over management of other companies. An acquisition may be friendly or hostile. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the target’s board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one.
Reverse take-over: When a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover.
Distinction between Mergers and Acquisitions
Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisition mean slightly different things. When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer “swallows” the business and the buyer’s stock continues to be traded. In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a “merger of equals.” Both companies’ stocks are surrendered and new company stock is issued in its place.
Regardless of their category or structure, all mergers and acquisitions have one common goal: they are all meant to create synergy that makes the value of the combined companies greater than the sum of the two parts. The success of a merger or acquisition depends on whether this synergy is achieved.