What Is An Acquisition, and How Does It Work?

An acquisition is a strategic move to buy a controlling stake in another company, gaining control over assets and operations. Discover the pros and cons.

by | Last updated 28 Mar, 2023 | Mergers & Acquisitions

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An acquisition is when a company purchases all the assets of another business to gain control over it. These deals are a type of business combination and can come in all shapes and sizes. 

Smaller bolt-on acquisitions are usually when a large enterprise takes over a small business with a promising product or service. This is quite common in the drug development and technology industries. Alternatively, large-scale acquisitions are between two more mature corporations. And if the firms are of equal size, it may evolve into a corporate merger.

What is an acquisition?

A business acquisition is the process of one firm buying another. This is typically achieved by purchasing a controlling stake in the target company to take over operations and assume ownership of its assets.

Just like a corporate merger, an acquisition is a friendly process where both parties are in favour and set to benefit mutually. However, it’s possible that during negotiations, relationships break down. And an acquisition can transform into an attempted hostile takeover.

Depending on the size of the businesses involved, acquisitions can get very complicated. Therefore, these deals require a considerable team of lawyers, investment bankers, and financiers throughout the entire process.

The 10 stages of an acquisition

Acquisitions are expensive. And so, it should be no surprise that they require careful planning and due diligence, with each fine detail worked out in advance.

To alleviate risk, companies can spend months developing a plan. But there are far more steps involved in the acquisition process.

1. Develop a strategy

Once a business has decided that an acquisition is the best course of action to achieve its goals, the planning stage begins. Some common examples of early-stage considerations include:

  • What is the desired outcome of an acquisition?
  • What will be the end operating model?
  • How will the deal be financed?
  • Will merger & acquisition (M&A) specialists need to be brought on board?

2. Find a target company

With a plan in place, businesses now need to go out and find a potential target firm that meets the specified criteria. This usually requires the help of corporate lawyers, especially for corporations with complex structures and subsidiaries.

3. Corporate valuation

Once a target firm has been identified, the acquiring company needs to estimate a fair value for the business.

For public corporations finding critical information is far more straightforward as a near-complete list of financial statements can be found under regulatory filings. When targeting a private company, valuation can often be trickier. And it may require the help of a private equity firm.

4. Tender offer

With a price point in mind, a tender offer can be formally presented to the target company’s board. More often than not, the offered price is rejected, and negotiations begin.

Usually, the target firm will announce the bid publically and invite other companies to join in the hopes of sparking a bidding war. The goal is to gain leverage in the negotiations while driving the acquisition price up.

5. Due diligence

During the negotiations, acquisition terms are discussed in more detail. The acquiring company will also typically gain access to confidential internal documents for legal and financial analysis. The due diligence process is by far the most time-consuming part of an acquisition.

Scrutiny of internal and external documents can reveal hidden assets or liabilities that may fundamentally change the quality of the proposed deal.

6. Sign a deal

Once due diligence is complete and a price is negotiated, an acquisition deal will be signed if everyone is happy. If the target company refuses to sign an agreement, the acquiring firm has two options. Either they can walk away, or the friendly acquisition will become a hostile takeover.

7. Gain approval

In a friendly acquisition, the signed deal will be presented to shareholders with a recommendation from management. In a hostile takeover, the acquiring company will bypass the board of directors and present its offer directly to shareholders. Shareholders will then have a vote to approve or reject the bid.

However, even if shareholders give the green light, the deal still needs approval from regulators. And that can be difficult to receive in industries such as defence due to national interests. Similarly, acquisitions potentially resulting in a monopoly will often be blocked. But the acquiring company may be able to sway the regulator’s favour by agreeing to some concessions or by promising to divest certain parts of its operations.

8. Secure financing

If shareholders and regulators approve of an acquisition, the time has come to pay the piper. Financing agreements are usually established early in the acquisition planning process. However, the final details typically don’t emerge until the due diligence stage.

Securing financing is fairly straightforward for companies using their own stock or cash to pay for an acquisition. But usually, these deals require debt financing from a lending institution such as a bank. Alternatively, firms can decide to issue bonds to the public debt market.

9. Corporate integration

With the cheques sent, the acquiring firm is now the owner and operator of the target company. But the work doesn’t stop there. Now the time has come to integrate the acquired assets, business model, regulatory responsibilities, and employees into the business.

Needless to say, it’s a complicated process. And this stage is where most of the unexpected expenses emerge. Clashes in corporate culture, redundancies, and changes in operating models can create quite a volatile environment for employees. Consequently, many may be fearful of potentially losing their jobs. This drives down productivity. And if integration is not handled correctly, it could destroy shareholder value.

10. Post-acquisition duties

Once an acquisition is completed and integrated, the acquiring company’s responsibilities don’t end. Agreements made during the negotiations with the target company and regulators must be upheld. Failure to do so may result in costly legal action.

Types of acquisitions

Many different types of acquisitions can be executed.

  • Vertical Acquisition– A vertical acquisition occurs between two companies operating at different levels of the supply chain within the same industry. These deals are often pursued to create synergy in pursuing higher operating efficiency.
  • Horizontal Acquisition– A horizontal acquisition occurs between two companies operating at the same level of the supply chain within the same industry. These firms are often direct competitors that agree to combine to achieve economies of scale.
  • Conglomerate Acquisition– A conglomerate acquisition combines two businesses operating in different industries with no overlap. This type of acquisition agreement is relatively rare and usually can only be executed if it directly increases shareholders’ wealth.
  • Congeneric Acquisition– In a congeneric acquisition, companies from the same industry but involved in unrelated operations or services come together. This allows new products to be quickly brought to the market, access a wider pool of potential customers, and secure new market share.

Advantages of an acquisition

The advantages of acquisitions are similar to corporate mergers.

  • Enter Foreign Markets – Penetrating international markets can be challenging. Beyond the cost of exporting or moving production, a lack of understanding of the local culture can make success difficult. An acquisition with a firm that already has a foothold in a target market could drastically reduce the barriers to entry. This opens the door to new customers as well as expands a firm’s potential customer base.
  • Access New Growth – A larger entity can benefit from economies of scale, paving the way for cost reduction and higher margins.
  • Decrease Competition – With acquisitions, companies grow in size. And with more resources at hand, the newly formed enterprise is often more capable of handling competition. These deals also help similar firms avoid product duplication within a market.
  • Gain New Technology/Resources – Some companies have access to unique resources such as intellectual property like a patent or regulatory license that’s near impossible to replicate. Through an acquisition, businesses can tap into these potentially lucrative resources to establish market dominance.

Disadvantages of an acquisition

Just like a corporate merger, acquisitions have several drawbacks.

  • Expensive – The acquiring firm often has to pay a premium above the fair market value of the target company. This can drain financial resources. And if the performance of the acquired assets fails to meet expectations, it can result in the balance sheet becoming compromised.
  • Integration Costs – Combining two businesses can be expensive, with unforeseen complications when the deal is signed initially. Some common issues include:
    • Corporate Culture differences – When two companies join together, it also means two corporate cultures combine to form one. Contrasting mentalities and approaches can lead to tension among employees that can harm productivity as well as create internal conflict.
    • Job Redundancies – With acquisitions, many jobs, especially in administration, become redundant, ultimately resulting in unemployment.
    • Resignation of Key Personnel – Not every employee may be happy with the deal. As a result, some workers often choose to part ways, potentially leading to the loss of valuable talent. Acquiring and training replacement staff be exceedingly expensive.
  • Raises Prices – With reduced market competition, acquisitions can increase product prices, making things more expensive for customers.
  • No Guarantee of Value creation – An acquisition aims to form a new company that can create value for shareholders. However, unforeseen complications and over-expectations can destroy value rather than create it, leaving shareholders worse off.

Acquisition vs Takeover vs Buyout vs Merger

Acquisition, Takeover, Buyout, and Merger all have one thing in common. In each scenario, two or more companies combine together to form one. However, despite the terms often being used interchangeably, they have some contrasting differences. And not all of them are pleasant.

  • Acquisition – An acquisition is a friendly takeover between two firms that benefits all the parties. The acquiring company, individual, or asset management fund approaches a target company’s board of directors with a tender offer to acquire the company in its entirety. If the board, shareholders, and regulators agree to the deal, the acquisition is executed, and business ownership changes hands.
  • Takeover – Sometimes, acquisition offers are not welcome. But if the prospective buyer is persistent, a forced takeover may occur. This is when the board of directors are bypassed entirely, and the acquirer goes straight to the shareholders with an offer.
  • Merger – A mutual union of two or more companies into one new corporation.
  • Buyout – A buyout is similar to a takeover. It’s often executed by purchasing or controlling majority equity in the company.

The bottom line

The acquisition is a smart strategic move to expand a business. It has its benefits and some downsides. Therefore, not every company is suited for this investment move.

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This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment is dependent on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial adviser if necessary.

Written By

Saima Naveed

Saima spent the early days of her career advancing the finance office of a prominent manufacturing business. After taking a sabbatical, she decided to use her expert knowledge and apply it to the stock market. Now, 10 years later, she manages a substantial portfolio built using detailed and thorough analysis.

Outside The Money Cog, Saima is an avid supporter of empowering women in the workplace. She is currently working very closely with Women of Wonders Pakistan to help other women achieve their career goals.

Current Holdings

PSX: CENERGY, PSX: FFL, PSX: PCAL, PSX: PKGS, PSX: SHEZ, PSX: SIEM

Edited & Fact Checked By
Zaven Boyrazian MSc

Zaven has worked in several industries throughout his career, from aircraft factories to game development studios. He has been actively investing in the stock market for the better part of a decade, managing over $1 million across multiple portfolios.

Specializing in corporate valuation, Zaven employs a modern take on the principles set out by Benjamin Graham to find new opportunities at fair prices.

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