Three major characteristics of mergers are discussed.

Form of Acquisition

A merger transaction may take one of two forms.

• Stock purchase: The acquirer gives the target company's shareholders some combination of cash or securities in exchange for share of the target company's stock.
• Asset purchase: The acquirer purchases the target company's assets and payment is made directly to the target company.

Method of Payment

The method of payment for a merger can be cash, securities, or a mixed offering with some of both.

In a stock offering, the exchange ratio determines the number of shares that stockholders in the target company will receive in exchange for each of their shares in the target company. The total compensation depends on:

• The exchange ratio.
• The number of outstanding shares of the target company.
• The value of the stock given to target shareholders.

There are several factors to be considered when a firm is negotiating with a target over the method of payment:

• The form of payment has an impact on the distribution of risk and reward between acquirer and target shareholders.
• If the acquirer's stocks are considered to be overvalued, the acquirer is likely to use stock offering as the method of payment.
• The acquirer's capital structure will be changed.

Mind-Set of Target Management

A merger can be viewed as either friendly or hostile.

Friendly Mergers

Most mergers and acquisitions are negotiated in a friendly environment. Friendly mergers are endorsed by the target company's managers.

• Each party conducts due diligence to confirm the accuracy of assertions made during negotiations.
• The definitive merger agreement contains the details of the transaction.
• The target company's management endorses the merger and recommends its shareholders to approve the transaction. If the shareholder approval is required, a proxy statement is given to shareholders in anticipation of their vote.

Hostile Mergers

Many mergers are friendly transactions where the management of the two firms negotiates a mutually acceptable deal. But some acquisitions are hostile takeovers, where the target firm, or the management of the firm, is not keen on the merger. This leads to defensive tactics aimed at stopping the merger. What follows is often a battle of legal wits and firepower between the two firms. A colorful language has sprung up around takeover battles.

• The acquirer may use a process called bear hug to submit a merger proposal directly to the target's board of directors.
• The acquirer can go over the head of the unwilling target firm's management using tender offers inviting shareholders to sell shares directly to the acquiring firm.
• Once the acquirer has enough shares or shareholder support, it can start a proxy fight to get the needed support from the board of the target firm.

Target managers have a variety of defense mechanisms at their disposal. This subject will be discussed next.