Why Do Companies Buy Other Companies?

Part of the Investment Banking For Dummies Cheat Sheet

Whenever you buy stock in a company, more likely than not, you're buying a sliver of that company. But for some investors, a small sliver isn't enough.

Companies are constantly scanning the corporate landscape for other firms that may be for sale, or may own assets that are worth buying. Buying companies can be a risky proposition. After all, the only way to buy a healthy company is to offer a price higher than the current market price, called a premium. By paying up for the company, the buying company had better make the right moves to get the deal to work. Investment banks help companies on the prowl find buyout targets, make the deal, and sometimes even finance it.

But despite the huge possible risks of buying companies, it's still attractive for a variety of reasons, including the following:

  • Access to a new geography: Success in business is increasingly a matter of tapping global demand. It's not enough to just have a hit product selling like hotcakes in the United States, because companies quickly grow by selling to consumers around the world. Getting up to speed with international sales, though, takes time, money, and know-how into the vagaries of different markets. Sometimes buying a company that's already set up in a foreign country can speed up time to market.

  • Access to an interesting technology: Small companies, often financed by investors willing to go for a home run, can often afford to take big chances in research. And when these small companies make major discoveries or create products that reinvent categories, larger companies may look at them enviously. Meanwhile, to turn a small company into one big enough to distribute products worldwide takes money and time the company may lack. These factors combine into why it's often best for an established company to buy a smaller one. The established company can quickly incorporate the technology into its products and get it out into the hands of consumers.

  • Vertical integration: Companies relying on important raw materials can often find themselves beholden to the suppliers of those materials. If the raw materials are important enough to the success of a company, it may be in the company's best interest to buy the supplier and lock up the access to the goods.

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