Through acquisitions, companies can expand their operations and gain access to new products or technology more quickly than they can organically.
In this article, you’ll learn everything you should know about an acquisition, including its definition, benefits, valuation, and more.
Let’s dig in.
What does acquisition mean?
Acquisition is a term used to describe the process by which one company acquires another. This can be done either through an outright purchase of the company's assets or through a merger, in which two companies combine to form one larger business. In either case, an acquisition involves the transfer of ownership and control from the acquired company to its new owner.
For startups, acquisitions can be an effective way to grow quickly and gain access to new resources.
The primary goal of acquisitions is often for one company to expand its market share, increase its customer base or gain access to new technologies. Acquisitions can also be used to diversify one company's portfolio and reduce risk by spreading out investments across different sectors.
It is different than a merger or a takeover, and there are many different types of acquisitions.
What are the benefits of startup acquisitions?
Acquisition is a common strategy used in business to achieve various goals. Here are some of the main ones:
- Customers & employees: Acquiring another startup or established company enables a business to acquire additional customers and employees with specialized skills that could take much longer for the startup to develop in-house.
- Technology: Acquisitions can also give startup access to new technology and resources that could help the company expand its operations more quickly than would otherwise be possible.
- Credibility: An acquisition can help a startup to gain credibility in the market and increase its brand recognition.
- Exits: Acquisitions are often used as exit strategies for startups that have been successful but want to cash out their investments or expand into new markets quickly.
What is the difference between a merger and an acquisition?
The main difference between a merger and an acquisition is that in a merger, two relatively equal companies combine to form one new entity. The shareholders of each company receive shares in the new entity.
In an acquisition, one company purchases the assets or shares of another and gains control over it without forming a new legal entity. The acquiring company usually pays cash, stock, or other consideration to the shareholders of the target startup in return for giving up their ownership.
The shareholders of the target company are usually left with no stake in the combined entity following an acquisition, although they may receive financial compensation for their shares.
Mergers typically occur when two companies see a mutual benefit from combining forces and creating one new entity, while acquisitions usually involve a larger company acquiring the assets or shares of another to gain control and expand its operations.
Acquisitions vs takeover: what’s the difference?
The main differences between an acquisition and a takeover are the level of consent from the target company, as well as their implications.
An acquisition is typically friendly in nature, with the target company's board of directors approving and consenting to it.
This type of transaction is typically beneficial for both parties, with strategies in place to ensure that appropriate assets are purchased and that any financial obligations associated with them are considered.
On the other hand, a takeover is usually hostile as it often does not have consent from the target company's board of directors. This type of transaction implies an imbalance between parties involved in terms such as power or prestige.
Thus, acquiring firms may be forced to purchase large stakes of their targets' stock to gain control over them.
How to do startup acquisition valuation?
One of the main acquisition process steps is valuation. The best approach for startup acquisition valuation depends on the specific circumstances of each company, and there is no one-size-fits-all solution.
Different methods may be more appropriate in different situations, but here are some popular methods for acquisition value calculation:
1. Comparable company analysis
This method is used to compare a startup’s value with similar companies in its sector and industry.
This analysis involves looking at key financial metrics such as revenue, gross margin, operating expenses, and profit margins. It also takes into account market conditions, industry trends, and the sector’s overall growth potential.
This method is particularly useful when a startup has already achieved significant traction in its space or if there are similar companies that have recently been acquired.
2. Discounted cash flow method
This approach values startups based on the present value of projected future cash flows. It takes into account current financials such as revenue and expenses, then projects these figures out over a period of time to predict what the company’s performance would be in five or more years.
This method is especially appropriate for startups with little past performance data but lots of potential growth in their sector or industry.
3. Earnings multiple valuation method
This method values companies by multiplying their earnings (or other key metrics) by an industry-specific multiple.
This method is used to compare a startup’s performance with its peers and the overall market, in order to determine whether it is undervalued or overpriced relative to other companies of similar size and sector.
4. Asset valuation method
This approach values startups based on their tangible assets, such as physical property, equipment, and inventory.
This method is often used by acquirers who are looking to purchase a startup in order to gain access to its assets or resources more quickly than if they were building those same assets from scratch.
What are the types of acquisitions?
For startups looking to expand their horizons, there are a variety of acquisition strategies available. Here are the main ones:
1. Horizontal acquisitions
Horizontal acquisitions involve the acquisition of a similar business in the same industry. This type of merger is often used to eliminate competition and quickly increase market share, but it can also be subject to antitrust laws as established by the Federal Trade Commission (FTC).
2. Vertical acquisitions
Vertical acquisitions take place when a company buys another that falls in a different position on the supply chain, either higher or lower. This type of acquisition is often used to save money and make companies more independent from external vendors.
3. Congeneric acquisitions
Congeneric acquisitions involve the purchase of a company in an unrelated industry. This type of acquisition is often used to protect companies from market fluctuations and provide smaller businesses with stability through their new parent company.
4. Conglomerate acquisition
A conglomerate acquisition occurs when one firm purchases another from a completely unrelated industry. This type of acquisition is often used to increase market share and enter new markets without having to compete with existing brands.
Acquisition: Key takeaways
- Acquisition is the act of one company taking control over another by purchasing a majority stake in its shares.
- The primary goal of an acquisition is often to expand market share, increase customer base or gain access to new technologies.
- Acquisitions can also be used as exit strategies for startups that have been successful but want to cash out their investments or expand into new markets quickly.
- The main difference between a merger and an acquisition is that in a merger, two relatively equal companies combine to form one new entity, while in an acquisition, one company purchases the assets or shares of another and gains control over it without forming a new legal entity.
- There are various methods for startup acquisitions, such as comparable company analysis, the discounted cash flow method, the earnings multiple valuation method, and the asset valuation method, which can be used depending on the specific circumstances of each individual case.
Disclaimer: LTSE is neither a law firm nor provides legal advice. Before making decisions on matters covered by this post, readers should consult their legal adviser.