Acquisition

What Is an Acquisition?

An acquisition occurs when one company, called the acquirer, takes ownership of another company or a significant part of its business. The target may be bought outright, or the acquirer may purchase enough of its common stock to gain control. Companies use acquisitions to grow, enter new markets, add products or technology, or reduce competition.

How an Acquisition Works

Acquisitions are usually structured in one of two ways. In a stock purchase, the acquirer buys the target's shares from its shareholders, and the target becomes a subsidiary of the buyer. In an asset purchase, the acquirer selects specific assets and liabilities, such as equipment, brands, or customer contracts, and leaves the rest of the company behind.

Before closing, the buyer typically conducts due diligence to examine the target's finances, contracts, and legal risks. A public company may receive an offer directly from a bidder who asks shareholders to sell their shares at a stated price, known as a tender offer. Payment can be cash, the acquirer's own stock, or a mix of both. Buyers often pay more than the target's recent market value, a premium that reflects the expected benefits of gaining control, sometimes called a control premium.

Why It Matters to Investors

For shareholders of the target, an acquisition often means selling at a price above the recent trading level. For shareholders of the acquirer, the outcome is less certain. A deal may add revenue or cost savings, but it can also overpay, add debt, or fail to combine the businesses effectively. When the purchase price exceeds the fair value of the target's identifiable net assets, the difference is recorded as goodwill on the acquirer's balance sheet. If the acquired business underperforms, the company may later have to write that goodwill down, which reduces reported earnings.

Acquisitions can be funded with cash on hand, new debt, or newly issued shares. A deal financed heavily with borrowed money, such as a leveraged buyout, carries additional risk. Large transactions may also face review by competition authorities before they can close. A closely related idea is a merger, in which two companies combine, although the two terms are often used loosely.