External development is a form of business growth that results from the acquisition, participation, association, or control of a company, companies, or assets of other companies, expanding their current businesses or entering new ones. The reasons for a company to decide on external development (mergers, acquisitions, alliances, etc.) versus internal development have their origin in different causes among them:
1. Economic reasons
Cost reduction: Through economies of scale and economies of scope by integrating two companies whose productive, commercial systems are complementary to each other, generating synergies.
Obtain new resources and capabilities by joining or acquiring another company.
Replacement of the management team: It usually happens that there is a more significant increase in value when the management is replaced.
It is obtaining tax incentives that can increase the benefits of acquisitions and mergers due to exemptions or bonuses.
2. Market power reasons
It may be the only way to enter an industry and a country because it has substantial entry barriers. When mergers and acquisitions are horizontally integrated, an increase in the resulting company’s market power is sought and, consequently, a reduction in the level of competition in the industry.
When the mergers and acquisitions are of vertical integration, companies that act in different stages of the productive cycle are integrated; the objective is to immediately achieve the advantages of vertical integration, both backward and forwards.
Types of external development
Company mergers: Integration of two or more companies to at least one of the original companies disappears.
The acquisition of companies: Operation of purchase and sale of packages of shares between two companies, keeping each of them’ legal personality.
Cooperation or alliances between companies: Intermediate formula, links, and relations are established between the companies, without loss of legal personality of any of the participants, which maintain their legal and operational independence.
Depending on the type of relationship established between the companies, they can be classified as follows.
Horizontal: The companies are competitors among themselves and belong to the same industry.
Vertical: The companies are located in different phases of the complete cycle of exploitation of a product.
Conglomerates: The companies have very different activities from each other.
The participation or acquisition of companies occurs when a company buys part of another company’s share capital to dominate it totally or partially.
The acquisition or participation in companies will give rise to different levels or degrees of control depending on the percentage of the share capital of the acquired company in its possession and according to how the remaining shares are distributed among the other shareholders: large packages of shares in the hands of very few individuals or, a large number of shareholders with little individual participation.
The purchase of a company can be made through a conventional purchase contract, but in the last decades, two financial formulas have been developed:
Leveraged Buy-Out (LBO). It consists of financing a significant part of a company’s acquisition price through the use of debt.
This debt is secured by the buyer’s equity or creditworthiness and the assets of the acquired company and its future cash flows. So after the acquisition, the debt ratio usually reaches very high values.
Public offer of acquisition of shares (OPA): It occurs when a company makes a purchase offer, of all or part of the share capital, to the shareholders of another listed company under certain conditions.