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Mergers of Equals - Complete Guide

Kison Patel
CEO and Founder of DealRoom
Kison Patel

Kison Patel is the Founder and CEO of DealRoom, a Chicago-based diligence management software that uses Agile principles to innovate and modernize the finance industry. As a former M&A advisor with over a decade of experience, Kison developed DealRoom after seeing first hand a number of deep-seated, industry-wide structural issues and inefficiencies.

CEO and Founder of DealRoom

Is a merger of equals possible?

This question usually follows a discussion about the nature of deals between companies of similar size and what drives them.

The answer is that yes, mergers of equals do exist, and in this article we provide an overview of how this type of deal works and the challenges that they bring.

What is a Merger of Equals?

As the name suggests, a merger of equals occurs when two companies of roughly equal size merge to create a new company. When the merger closes, shareholders from each of the companies receive shares in the newly formed company in exchange for the shares that they held in the two companies that made the merger. In the case of the merger of equals, the shares received by both parties will be close to parity, making them ‘equals’ in the merger.

How Does a Merger of Equals Work?

Mergers of equals are relatively uncommon, with the thinking being that company managers are reluctant to give up their own power, even if it means creating a company for shareholders which is almost twice the size of the current company.

For a deal to happen, one company’s CEO is almost certainly going to have to give up his or her position (Co- CEOs, like the ones Goldman Sachs has had are uncommon), and suddenly the deal doesn’t seem so equal anymore.

If this barrier can be overcome, it’s important to look at the valuation.

Remember that just because two companies operate in the same industry, the same geography, and have almost identical target markets, may have different values and growth prospects.

Those involved in structuring the deal need to consider these differences objectively, without becoming prisoner to the ‘merger of equals’ label attributed to the deal.

When the two companies have been valued - and both parties have agreed to their own valuation and that of the other company - the NewCo is based on the consolidated financial statements of both companies. The shares are typically divided on a pro-rata basis in the new company (i.e., if the valuations showed that one company was worth 5% more than the other, its shareholders will receive 5% more shares).

Having agreed to the structure in the new company (management level changes, changes to branding, marketing and sales, etc.), the newly formed company should in theory be able to enjoy the benefits of scale explicit in doubling a company’s size in a short period of time.

And of course, as a merger of equals, there are sure to be several co stand revenue synergies that can be enjoyed by the newly formed company.

Challenges in Mergers of Equals

The previous section gave a somewhat prosaic version of how mergers of equals happen.

In reality, true mergers of equals are uncommon because of the challenges that they bring, principally in management.

Here are just some examples of the challenges faced:

The agency challenge

The relative rarity of mergers of equals suggests that managers are often looking out for themselves rather than their shareholders. A merger of equals would demand that one CEO give up his position to the other, despite managing a virtually identical company.

“Everyone wins except me”

says the disgruntled CEO and passes up the opportunity.

The organizational structure challenge

The issue of who take the CEO role can be repeated all the way down the organizational chain. Who takes the CFO role if there are two CFOs? Who’s head of strategy?Etc.

It’s not that these issues aren’t common in every large M&A transaction, but they tend to dog mergers of equals more, with many involved in the deal feeling the spirit of the deal isn’t reflected in the outcomes.

The antitrust challenge

When two companies are of equal standing and competing ferociously, the customer tends to benefit more. When they come together, the opposite is the case. This tends to be truer as their market share increases.

Thus, the antitrust commission often takes a very skeptical view of ‘mergers of equals’ for this reason.

The culture challenge

When a large company acquires a small company, it’s generally quite clear whose culture is going to be pervasive after the deal.

But when two companies of equal size - perhaps with remarkably different corporate cultures- come together: Who is going to yield? Small issues around the office suddenly become deal breakers and the moniker ‘merger of equals’ can even tend to drag down the deal rather than acting as a catalyst for it.

Example of a Merger of Equals

The example of the merger between the banking industry giants Citi and Travelers in 1998 is a textbook example of a merger of equals.

citibank logo

Shareholders of each of the two companies agreed to divide the shares in the new company - which became Citibank - almost equally between them

Furthermore, management adopted a ‘Noah’s ark’ strategy when composing the new management team: every top management position was in twos. Two CEOs, two COOs, etc. The board was divided evenly between the former employees of Citi and Travelers.

In some respects, the deal was an undoubted success: In the 18 months after the deal closed, net profits increased from around $6 billion (achieved from combining the net profit of both Citi and Travelers before the transaction) to just under $10 billion.

And in the age before fintech, the newly formed Citibank was the first bank to offer its retail and corporate clients every financial product under the sun. Its status as the world’s largest bank by market cap ($84 billion after the deal was announced) also gave it considerable power in global markets.

Conclusion

The terminology in M&A can often be overemphasized at the expense of good practice.

Mergers of equals are a casein point. Students commonly argue: “if two companies can never be identical, how can they be equal?”

It’s a fair question but an academic one.

The M&A Science Academy includes a range of courses and podcasts that cover this and several other questions like it, while emphasizing the importance of strong M&A practice rather than theory alone.

The academy is designed for anybody that wants to take their M&A practice to the next level.

M&Ascience podcasts and lessons

Is a merger of equals possible?

This question usually follows a discussion about the nature of deals between companies of similar size and what drives them.

The answer is that yes, mergers of equals do exist, and in this article we provide an overview of how this type of deal works and the challenges that they bring.

What is a Merger of Equals?

As the name suggests, a merger of equals occurs when two companies of roughly equal size merge to create a new company. When the merger closes, shareholders from each of the companies receive shares in the newly formed company in exchange for the shares that they held in the two companies that made the merger. In the case of the merger of equals, the shares received by both parties will be close to parity, making them ‘equals’ in the merger.

How Does a Merger of Equals Work?

Mergers of equals are relatively uncommon, with the thinking being that company managers are reluctant to give up their own power, even if it means creating a company for shareholders which is almost twice the size of the current company.

For a deal to happen, one company’s CEO is almost certainly going to have to give up his or her position (Co- CEOs, like the ones Goldman Sachs has had are uncommon), and suddenly the deal doesn’t seem so equal anymore.

If this barrier can be overcome, it’s important to look at the valuation.

Remember that just because two companies operate in the same industry, the same geography, and have almost identical target markets, may have different values and growth prospects.

Those involved in structuring the deal need to consider these differences objectively, without becoming prisoner to the ‘merger of equals’ label attributed to the deal.

When the two companies have been valued - and both parties have agreed to their own valuation and that of the other company - the NewCo is based on the consolidated financial statements of both companies. The shares are typically divided on a pro-rata basis in the new company (i.e., if the valuations showed that one company was worth 5% more than the other, its shareholders will receive 5% more shares).

Having agreed to the structure in the new company (management level changes, changes to branding, marketing and sales, etc.), the newly formed company should in theory be able to enjoy the benefits of scale explicit in doubling a company’s size in a short period of time.

And of course, as a merger of equals, there are sure to be several co stand revenue synergies that can be enjoyed by the newly formed company.

Challenges in Mergers of Equals

The previous section gave a somewhat prosaic version of how mergers of equals happen.

In reality, true mergers of equals are uncommon because of the challenges that they bring, principally in management.

Here are just some examples of the challenges faced:

The agency challenge

The relative rarity of mergers of equals suggests that managers are often looking out for themselves rather than their shareholders. A merger of equals would demand that one CEO give up his position to the other, despite managing a virtually identical company.

“Everyone wins except me”

says the disgruntled CEO and passes up the opportunity.

The organizational structure challenge

The issue of who take the CEO role can be repeated all the way down the organizational chain. Who takes the CFO role if there are two CFOs? Who’s head of strategy?Etc.

It’s not that these issues aren’t common in every large M&A transaction, but they tend to dog mergers of equals more, with many involved in the deal feeling the spirit of the deal isn’t reflected in the outcomes.

The antitrust challenge

When two companies are of equal standing and competing ferociously, the customer tends to benefit more. When they come together, the opposite is the case. This tends to be truer as their market share increases.

Thus, the antitrust commission often takes a very skeptical view of ‘mergers of equals’ for this reason.

The culture challenge

When a large company acquires a small company, it’s generally quite clear whose culture is going to be pervasive after the deal.

But when two companies of equal size - perhaps with remarkably different corporate cultures- come together: Who is going to yield? Small issues around the office suddenly become deal breakers and the moniker ‘merger of equals’ can even tend to drag down the deal rather than acting as a catalyst for it.

Example of a Merger of Equals

The example of the merger between the banking industry giants Citi and Travelers in 1998 is a textbook example of a merger of equals.

citibank logo

Shareholders of each of the two companies agreed to divide the shares in the new company - which became Citibank - almost equally between them

Furthermore, management adopted a ‘Noah’s ark’ strategy when composing the new management team: every top management position was in twos. Two CEOs, two COOs, etc. The board was divided evenly between the former employees of Citi and Travelers.

In some respects, the deal was an undoubted success: In the 18 months after the deal closed, net profits increased from around $6 billion (achieved from combining the net profit of both Citi and Travelers before the transaction) to just under $10 billion.

And in the age before fintech, the newly formed Citibank was the first bank to offer its retail and corporate clients every financial product under the sun. Its status as the world’s largest bank by market cap ($84 billion after the deal was announced) also gave it considerable power in global markets.

Conclusion

The terminology in M&A can often be overemphasized at the expense of good practice.

Mergers of equals are a casein point. Students commonly argue: “if two companies can never be identical, how can they be equal?”

It’s a fair question but an academic one.

The M&A Science Academy includes a range of courses and podcasts that cover this and several other questions like it, while emphasizing the importance of strong M&A practice rather than theory alone.

The academy is designed for anybody that wants to take their M&A practice to the next level.

M&Ascience podcasts and lessons
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