There are a lot of reasons why it makes sense for a business owner to purchase another company, even when the company they currently own is thriving.
The acquisition of another business can be used to give the buyer's company a strategic advantage, to secure a technological process or even to buy out a competitor. But whatever the motivation, the end result is that the buyer's business – and frequently even the seller's business – are stronger and better-equipped for the marketplace.
When most people think about merger and acquisitions, they assume that the buyer has substantial cash resources or the ability to obtain financing through lenders and investors. But that isn't always the case. Rapidly growing companies that have invested cash and funding capital into the business are often hard-pressed to rally additional capital for the purchase of another business.
The irony is that although the buyer lacks acquisition capital, the acquisition of another business can propel their company to a whole new level. In many cases, the acquisition of a competitor or a cutting edge technological process can even create conditions that are ripe for an IPO or acquisition by a much larger corporation. If the buyer isn't able to acquire the other company at the right time, the company could be purchased by someone else who will reap the benefits.
A shortage of cash or finance equity doesn't necessarily mean that the buyer can't acquire the other company. Instead of funding the sale through traditional means, it's possible to structure a stock deal in which the seller is compensated with shares of stock or ownership equity. The preconditions for this kind of deal are that the buyer's company is incorporated or is on the verge of being acquired by a larger business interest. If either of those conditions has been met, there are at least three ways the buyer can use stock to buy a business.
- Shares in the buyer's company. One way to compensate the seller is by issuing shares in the buyer's company. If the buyer's company is experiencing rapid growth, this could eventually multiply the seller's profits. After a predetermined holding period, the seller can cash in their stock and walk away with more profits than they would have received in a cash sale.
- Shares in a merged business. If the acquisition results in a merger or the creation of a new company, the seller can be compensated with stock in the new business enterprise. This type of deal is based on the belief that the sum of the two companies is greater than their parts and can also result in higher profits for the seller.
- Equity funding in anticipation of a buy-out. If the buyer's company is on the verge of being acquired by a larger corporation, the buyer and seller can enter into a quasi-partnership that gives the seller an equity share in the final sales price. The buyer and the seller both have an interest in a quick acquisition and in making the merged company an appealing acquisition target.