Jargon buster: mergers and acquisitions

Our expert explains key terminology around an important, sometimes opaque, and often headline-grabbing aspect of the financial markets.

Mergers and acquisitions, generally shortened to M&A, are frequently at the top of the market news agenda.

When two firms become one it is often a headline-grabber, particularly if they are big companies or well-known names for other reasons.

It’s not just the media that should be concerned with them, however, as they can have serious implications for your investment pot if you hold shares in a company involved in one of these deals.

Typically, it’s a good thing for shareholders in a company that is the target of a takeover. To entice acceptance of any bid, the companies involved will have to make it lucrative for shareholders and offer significantly more for the shares than their price on the open market.

In the short term that’s a clear win. However, it is not that simple as in the medium and long term there is often a possibility that the company could be very successful on its own. In some cases, holding on to your shares would have been more profitable.

There is also potential downside if you own shares in the bidding company as it will often be using a large amount of its cash to fund the deal, rather than dishing it out as a dividend or conducting a share buyback.

It may even take on new debt to raise the money, which can cause a hit to the share price in the short term.

M&A deals come with a range of terminology attached that is important for investors to have a good grasp of to make informed decisions.

Here, we outline the most important terms to understand:

Merger

A merger is when two or more companies are folded into one another to become one, in their mutual interest. It is generally agreed on all sides, with the backing of a majority of shareholders in each company.

Acquisition

This is where there is a clear bidder, or buyer, and a target. In most cases the bidder is the larger company, but not always.

Acquisitions, also known as takeovers, can be friendly or hostile. With the former, the board and senior management of the target will agree to the deal and advise shareholders to accept the offer.

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Hostile takeover

In a hostile takeover, the target company’s bosses will be against the deal as they believe the company will be more successful on its own. In this instance the bidder can bypass them and make an offer directly to the shareholders of the target company without their consent.

Competitive bid

When more than one company is bidding to acquire a target. This is great for the target’s shareholders as it forces the price up in an auction-like scenario.

Cash offer

The simplest form of bid. It does what it says on the tin. The bidder will offer a set amount of cash per share.

Scrip offer

This is where the bidder will offer the target's shareholders shares in itself or the newly merged company instead of cash. It can also be referred to as just a “shares-based deal.” This can replace cash entirely or be added on top to create a mixed offer. 

Exchange ratio

In a scrip deal this is the number of shares in the bidding company investors will receive for each share they hold in the target.

Undisturbed share price

This is the price of the company’s shares before there was any public knowledge of a takeover or merger happening.

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Takeover premium

This is the juicy part. It is the amount of money above the undisturbed share price the bidder is offering. It is the incentive for shareholders to accept a bid.

Deal rationale

The main reasons the companies believe a merger or acquisition is a good idea and will benefit shareholders. These vary greatly, but often stem from “bigger is better” arguments.

Economies of scale

This is often a major part of the rationale. It refers to the lower costs and increased profitably that can be derived by a company becoming bigger.

Synergies

Another central element of deal rationale. It refers to the cost savings that can be made by the companies merging. Typically, these stem from both firms having a certain function, such as accounts departments. Once merged, they need only one accounts department. 

Due diligence

The painstaking process of thoroughly checking every detail of a target company by the bidder’s lawyers and other advisers.

Regulatory clearance

A takeover will often be agreed subject to regulatory clearance. This means that while the financial details have been agreed between the firms, a deal is not final until the relevant market watchdogs and competition regulators have signed off on it.

Offer period

This is the set period of time investors have available to accept a deal before it is either finalised or withdrawn.

Leveraged takeover

The bidding company has taken on debt to fund the takeover rather than having the cash in hand already.

Irrevocable undertakings

Before announcing a bid, an acquirer will often secure binding agreements to accept an offer from some of the major shareholders in the target.

Mandatory bid

If an investor acquires 30% or more of a company's shares, regulators require them to make an offer for the whole company at a fair market value. Investors often avoid owning more than 30% of a company for this reason.

Scheme of arrangement

A particular structure for a takeover that is commonly used in the UK. It has a set timetable for each stage of the process and requires only 75% of shareholders to accept for the deal to go through.

Squeeze-out

If a bidding company reaches a certain threshold of acceptances of its bid, it is then allowed to force any remaining shareholders to accept so that the takeover can be completed. It is a very high bar though. Typically 90% plus.