Two letters in one week: Lena's Bakery Ltd has three shops, nine bakers and counter staff, and a queue every morning for its $3 loaf.
On Monday Sam Hartley writes. His family bakery has three shops in Brookfield, the next town, and he suggests the two businesses join into one company with six shops.
On Friday Goldcrust plc writes, for the third time. It wants to buy Lena's Bakery Ltd outright.
Both letters are ways to grow by joining a business that already exists, instead of opening new shops one at a time. In 1.5.1 that was external growth. What separates them is who ends up owning what.
Merger
- Two businesses agree to combine into one new, bigger business
- The owners of both swap their shares for shares in the new company
- Lena's and Hartley's would become one company with six shops, owned by both families
- Usually two businesses of similar size, joining as equals
Acquisition
- One business buys enough of another's shares to control it, usually more than half
- Both sides agree: the owners choose to sell
- Goldcrust would own Lena's Bakery, and the three shops would become part of Goldcrust
- Usually the bigger business buys the smaller one
Takeover
- An acquisition that the target's directors do not want (a hostile takeover)
- The buyer goes round the board and buys shares from the owners directly
- Only possible when the target's shares are traded on a stock exchange
- Goldcrust cannot do this to Lena's Bakery: it can only ask
Why Goldcrust has to ask: Lena's Bakery Ltd is a privately held company. Its shares can be sold to an outsider only if the shareholders agree (1.2.3), so Goldcrust cannot buy them behind Lena's back.
A publicly held company has no such shield. If Goldcrust wanted a rival plc, it could buy that company's shares on the stock exchange until it held more than half, whatever the rival's board said.
Look at what each deal does to Lena's say in her own business. After the merger the new company would have twice as many shares, so her 50% of Lena's Bakery would become about 25% of the new company, and every decision would be shared with the Hartleys. After Goldcrust's acquisition she would own nothing. She might still run the shops, but as a Goldcrust manager.
Three words, three meanings: Merger: two businesses combine as equals into one new business. Acquisition: one buys control of the other, and both agree. Takeover: an acquisition the target's board does not agree to.
Case studies often say 'takeover' for any purchase of control, friendly or not. When a question says 'take over', read it as buying control, then ask whether the other side agreed.
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The mill is for sale: The flour mill that grinds Valley Grain's wheat into Lena's flour is the only mill in the valley. Its owner, Tom Reeve, is retiring and asks $600,000 for it.
The mill made a profit of $60,000 last year. Lena's Bakery buys about a fifth of its flour; Goldcrust's shops in the valley buy most of the rest. Lena's Bakery has $200,000 in the bank.
What buying the mill would give Lena's Bakery
Its flour, guaranteed
No more late vans and no sudden price rises. The bakery would control the one input no loaf can do without, and the quality of the wheat that goes into it.
The mill's profit
The $60,000 the mill earned last year, most of it from selling flour to Goldcrust, would now belong to Lena's Bakery.
Growth in a month, not in years
Building a mill from nothing would take years and skills the bakery does not have. Buying one brings the building, the machines and eight millers who already know the work.
Something a rival cannot copy
Only Lena's Bakery would own the valley's mill. Goldcrust could not buy it first and use it against her.
The same reasons come up in almost every case: growing faster than the business could alone, a bigger share of the market, a way into a market or a group of customers it does not reach, skills, brands or technology it lacks, control of a supplier, and one competitor fewer. When the two together can do more than the two apart, the extra is called synergy. When Goldcrust wants Lena's Bakery, it is after three of those reasons: her customers, her name, and one less shop to compete with.
The price
- $600,000 is three times the bakery's cash, so $400,000 would be a loan
- The interest is due every month, whatever the mill earns
- Money spent on the mill is money not spent on the Mill Lane bakehouse
Running something new
- Nobody at the bakery has ever run a mill
- The millers work night shifts under a strict owner; the bakery's owners talk every morning over coffee
- Two ways of working have to become one
What comes with it
- Goldcrust buys most of the mill's flour. Will it keep buying from a mill its rival owns?
- If Goldcrust leaves, the $60,000 profit could turn into a loss
- The mill's problems come too: its main roller is thirty years old
The middle column has two names worth knowing. When two groups of people with different habits and values are put together, work slows and good people leave (a culture clash). Joining two sets of machines, rotas, pay rates and systems into one takes months and money (integration). Many acquisitions that fail do so here, long after the price has been paid.
Two questions for any purchase: What does the buyer get that it could not get as fast on its own? And what does it take on with it: the price and how it is paid, the people, and the problems the business already has?
A purchase is only as good as the answer to the second question.
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Goldcrust's third letter: Goldcrust plc offers $1.5 million for all the shares in Lena's Bakery Ltd. Lena would stay on to run the three shops for two years, as a Goldcrust manager.
Goldcrust's plan is to sell 'Lena's' bread in its 400 bakeries, made in its own factory to her recipe.
Every acquisition has two sides. In the last section the question was whether to buy. Now it is whether to sell, and for the owners of a small business that is a different weighing: money and reach against control and everything they built the business to be.
Reasons to sell
- Money for the owners. $1.5 million: $750,000 for Lena, about $495,000 for Marco and $255,000 for his cousin.
- Money for the business. Goldcrust can pay for shops and ovens that three owners could never fund themselves.
- Reach. Lena's bread on the shelves of 400 bakeries, with Goldcrust's lorries and advertising behind it.
- Safety. As part of a large company, the bakery no longer has to survive a price war with Goldcrust on its own.
Reasons to refuse
- Control. Lena would own nothing. She would run the shops for two years, and then Goldcrust decides.
- What the bakery stands for. Goldcrust bakes from frozen dough (1.3.1); Lena's loaf sells as hand-made bread from bakers paid a living wage.
- The people. Nine bakers and counter staff chose Lena's Bakery. A new owner may change their pay, their hours or their jobs.
- The name. Goldcrust could put 'Lena's' on factory bread, and the trust behind the $3 loaf could go with it.
Three owners, three answers: The offer goes to three shareholders, and they want different things. Marco's cousin, who does not work in the bakery, sees $255,000. Lena sees the end of her bakery.
In a privately held company none of them can sell to Goldcrust without the others' agreement (1.2.3), so the real decision is a negotiation among the three.
When you weigh an offer like this, ask what the owners want the business for. If it is the money, the offer answers it. If it is the bread, no price is quite high enough. Then say what the case does not tell you: here, whether Goldcrust would keep Lena's recipes, her bakers and her prices after the two years are up.
Buying a business is expensive, and merging means giving up control. Some businesses want the gains of working with a partner without either. There are two ways to do that.
Valley Loaf Ltd: Lena's Bakery Ltd and Valley Grain set up a new company together, Valley Loaf Ltd, to run a bakery café in the town's new market hall. It will sell wholegrain bread made from the farmers' own wheat.
Each puts in $40,000 and two people. Each owns half, and profits and losses are split equally. The bakery and the cooperative carry on as before; Valley Loaf is a third business that belongs to both.
That is a joint venture: two businesses create, own and run a new, third business together, sharing its costs, its profits and its risks. Neither partner is bought, and each keeps its own business and its own name. Many joint ventures are set up for one project or a fixed number of years.
What Valley Loaf gives each partner
- Shared cost and risk. Each risks $40,000, not the $80,000 the café costs.
- Skills put together. The farmers know wheat; Lena knows baking and what customers will pay.
- A market neither would try alone. A café in the market hall, with bread nobody else in town sells.
- Independence kept. The bakery and the cooperative stay exactly as they were.
What it costs each partner
- Half the profit. Every dollar Valley Loaf earns is split with the partner.
- Two owners must agree. Valley Grain decides by a vote of its forty members; Lena decides over coffee.
- Different ways of working. Two farmers and two bakers behind one counter can pull different ways.
- Shared blame. If Valley Loaf fails, both names are on it.
Second Helpings: an alliance: Lena's Bakery and Second Helpings sign a one-page agreement. Every evening the bakery's unsold bread goes to Second Helpings' kitchen. Second Helpings sells Lena's loaves in its café at lunchtime, and each year two of its trainee cooks spend a month with Lena's bakers.
No new business is set up and no shares change hands. Either side can end it with a month's notice.
That is a strategic alliance: two or more businesses agree to cooperate in a way that adds value for each of them, while staying fully independent. It is the cheapest and quickest way to work with a partner, and the easiest to leave. The price is that it is only as strong as the agreement. A partner can walk away, fall short, or damage your name: if Second Helpings were caught up in a scandal, the sign in Lena's window would tie her to it.
| Joint venture | Strategic alliance | |
|---|---|---|
| What is created | A new, third business | Nothing new: an agreement |
| Who owns what | Each partner owns a share of the new business | Nothing changes hands |
| Money in | Each partner invests in the new business | Little or none |
| Independence | Both keep their own businesses | Both stay fully separate |
| How it ends | The new business is closed, sold, or bought by one partner | Either side leaves under the agreement |
Hold on to the difference: A joint venture creates a new business that both partners own. A strategic alliance creates nothing new: two businesses agree to work together and stay separate.
Both are faster and cheaper than buying a business, and both depend on the partner keeping its side.
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How this comes up: Most often as the long question at the end of a case, for ten marks: discuss whether a business should take over another, whether an owner should sell, or whether to accept a joint venture or a strategic alliance. Some add a table of profits, margins or market shares to use.
Shorter questions ask you to define a merger, for two marks, or to explain one advantage and one disadvantage of taking over a named business, for four.
The ten-mark pattern
- Say what the deal is. A takeover, a merger, a joint venture or an alliance, and what the business wants from it.
- Argue for it with the case. Speed, customers, a new market, skills, control of a supplier: each with a number or a fact from the case.
- Argue against it with the case. The price and how it is paid, clashing ways of working, the target's own problems, what the owners give up.
- Weigh them. Which side is bigger, and which is more certain?
- Decide, with a condition and a limit. What you would do, what would change your mind, and what the case does not tell you.
Two traps: A list that fits any deal. 'Faster growth, more market share, culture clash' could be written without reading the case. Each point needs something only this deal has: its price, its debt, its people, its problems.
One side only. However strong the case for buying, half the question is what could go wrong.
Discuss whether Lena's Bakery Ltd should take over Hartley's Bakery.
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