Company Jargon Simplified

We often see certain terms in the newspapers and articles we read online such as mergers and acquisitions, liquidation, and so on. However, many of us have only some limited knowledge about these terms and may make some misinformed opinions and decisions subsequently. This article delves into some terms related to the setting up and fusion of companies.

Solvency: Solvency refers to the ability of a business organization to pay off its long-term debts and other financial liabilities. It is used as a litmus test to measure the health of a company, ie, a company that is solvent implies that the business is profitable and in a stable financial position.

Generally, the shareholders’ equity (the difference between a company’s assets and liabilities) spotlights the solvency position of a company, though some other methods may also be employed. At times, businesses in their early stages may show a negative value for the equity/capital, which doesn’t necessarily mean they are insolvent; the profit margin of early businesses is generally not high or the business may even be incurring losses.

However, a negative shareholders’ equity for mature companies insinuates that the company is likely to be insolvent. Sometimes, external events such as the expiration of Intellectual Property Rights, change in government regulations and obsolescence of the business idea can cause a company to become insolvent due to the lack of revenue, forcing it to shut or change its main business. Apart from the equity, certain solvency ratios such as the debt-to-asset ratio, debt-to-equity ratio, and so on are employed to get the solvency position of a business.

Merger: A merger refers to the voluntary fusion of 2 companies that have nearly equal operational capabilities and customer bases. This fusion leads to the creation of a new company into a novel legal entity. Post the merger, the shares of the new business are distributed among the foregoing shareholders. Two companies merge primarily to expand into new markets, reduce operational costs and sell common products. There are different types of mergers: -

· Conglomerate: The merger of two or more companies that specialize in unconnected business activities and overlapping factors; done to expand markets, reduce the costs of manufacturing, or increase the wealth of shareholders.

· Congeneric: The merger of two or more companies involved in the same market with overlapping factors such as R&D, marketing, and manufacturing; done to expand the consumer base and capture a larger market share.

· Horizontal: The merger of companies working in the same industry; done by competitors to gain a greater market share and utilize the benefits of large-scale production.

· Vertical: The merger of companies that operate at different levels of an industry’s supply chain; carried out to reduce costs.

Acquisition: An acquisition takes place when one company purchases more than 50% of the shares of the target firm to gain control over the latter’s decision-making capacity and assets. Usually, a larger company acquires a smaller one to eliminate competition, diversify products, reduce manufacturing costs, enter new markets (generally foreign ones), acquire novel technology, and reduce excess capacity (demand < supply). Acquisitions are classified broadly into:-

· Friendly Acquisitions: Acquisitions wherein the target firm’s Board of Directors agrees to be acquired as a way to mutually benefit from the deal.

· Hostile Takeovers: Acquisitions wherein the acquirer buys more than half the shares of the target firm without the latter’s free consent, usually done to eliminate competition.

Amalgamation: An amalgamation is the coalescence of three or more companies such that none of the constituent companies survive as distinct legal entities after the amalgamation. This is what discerns an amalgamation from a merger – in a merger, a company may absorb another into itself or two companies can merge into one new company; in an amalgamation, the constituent companies do not survive as separate entities and three or more companies join hands. An amalgamation is a consolidation of different companies operating in the same market into one large entity to gain the advantages of economies of scale (cost advantages attributed to large-scale production), share technology and other intellectual property, eliminate competition and increase assets and cash resources.