Mergers and acquisitions guide: Understanding the M&A process

Congratulations! Your company or client is considering an M&A—often the pinnacle of a company’s lifecycle. M&A transactions, while exciting, require a substantial lift from the management team, in-house legal team, external legal team, and tax and other external advisors to prepare for, negotiate, and close the deal. This guide will help direct you through your M&A transaction.

What is a merger and acquisition (M&A)?

Mergers and acquisitions (M&A) is the process of combining two businesses through a financial transaction. One company may purchase another outright, or two companies may merge into a single new entity. Either way, M&A is one of the most common exit strategies companies use to grow, enter new markets, or gain capabilities they do not have in-house. Leveraged buyouts (LBO), consolidations, acqui-hires, or restructurings are all terms that you may have heard that fall under the broader umbrella concept of M&A.

M&A affects a wide range of participants. Founders sell their companies. Private equity (PE) firms acquire portfolio companies, sometimes through a leveraged buyout or a management buyout. Public corporations make strategic acquisitions to stay competitive. Whether you are building a startup or managing a fund, understanding how M&A works has a direct effect on your equity, your team, and your business strategy.

What is the difference between a merger and an acquisition?

A merger happens when two companies of roughly equal size agree to combine into a single new entity. Both companies cease to exist in their original form, and shareholders on both sides receive shares in the new company. Both boards of directors must approve the transaction.

An acquisition happens when one company purchases another and takes ownership. The target company either becomes a subsidiary or ceases to exist as a separate entity. Acquisitions can be friendly, meaning both sides agree, or hostile, meaning the buyer bypasses the target's board and goes directly to shareholders.

In practice, many deals described as "mergers" are functionally acquisitions. One company's leadership typically ends up running the combined entity. Here is how the two structures compare:

• Merger: Two companies combine into a new entity. Both boards approve. Shareholders on each side receive shares in the combined company.

• Acquisition: One company purchases the other. The buyer takes control. The target may continue as a subsidiary or be absorbed entirely.

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M&A deal structures

There are three common structures for M&A transactions: a stock sale, an asset sale, and a merger. The type of transaction structure informs the level of due diligence, and the definitive documents and types of consents (both from stockholders and third parties) that will be required.

Merger

A merger occurs when two companies merge together to form one company. There are many different strategic motivations for mergers, and mergers can be financially and legally structured in different ways and even in combination with other deal types.

A merger is a true marriage of two companies. They file paperwork with the government saying that the two are now blending into one company. Mergers typically require approval by the board of directors and approval by a percentage of shareholders. Laws differ depending on what state you’re in and the governing documents for your company. 

Some common financial and legal structures for M&A include:

• A reverse triangular merger: The buyer forms a new subsidiary that merges with the target company, resulting in the target surviving the merger and becoming a wholly owned subsidiary of the buyer. This is the most common structure for corporate M&A.

• A recapitalization: The current owner sells a majority or controlling stake to a private equity firm and changes its structure of debt and equity.

• A leveraged buyout or leveraged recapitalization: A type of recapitalization where a private equity firm acquires a company with the help of debt funding, with the assets of the acquired company serving as collateral for the debt.

• A divisional carve-out or spin-out: When a company wants to divest a business line or set of assets, contributes the business line or set of assets into a new entity, and then sells the entity via a stock sale or merger.

Stock sale

In a stock sale, each shareholder in your company is selling their stock to a single buyer. The selling company then becomes a subsidiary of the buyer. The feasibility of this sort of deal depends on the size and organization of your cap table, and whether you can easily coordinate every person who owns stock in your company. Legal fees could mount if the logistical aspects of this structure are difficult to accomplish.

Asset sale

An asset sale occurs when the target sells all or substantially all of its balance sheet assets to the buyer, and then typically the company dissolves and pays the proceeds of the sale to the stockholders in the company wind-down process. Examples of the types of assets sold can be intellectual property, a product line, or a subsidiary of the business. Asset sales typically exclude liabilities, like outstanding lawsuits or debts, because the buyer doesn’t want to assume the issues that go along with those liabilities.

In some cases, partial asset sales can also involve the acqui-hire of specific teams (through new offers of employment with the buyer) and associated intellectual property. Any parts of the target company that were not sold off would continue to exist and operate without the acquired teams and associated IP.

→ Learn more about asset sales and stock sales

What are the types of M&A transactions?

M&A transactions are categorized by the strategic relationship between the companies involved including horizontal acquisition, vertical acquisitions, and conglomerate mergers. The type of deal determines the buyer's goals, the regulatory scrutiny it faces, and the integration challenges ahead.

Horizontal mergers

A horizontal merger combines two direct competitors in the same industry, performing similar distribution or production processes. The goal is typically to increase market share, eliminate overlapping operations, or achieve economies of scale through synergies. Because horizontal mergers reduce competition in a market, they attract the most regulatory scrutiny from antitrust authorities.

Vertical mergers

A vertical merger is an acquisition of a company in the same industry, with expertise at different stages of the distribution or production processes in order to reduce costs across the supply chain and increase overall efficiency in bringing the product or service to market. Backward integration means acquiring a supplier. Forward integration means acquiring a distributor or customer. The goal is to control more of the value chain, reduce costs, and improve coordination between stages of production and delivery.

Conglomerate mergers

A conglomerate merger combines companies in unrelated industries in order to extend corporate territories or product offerings to the customer. The primary driver is diversification — spreading risk across different markets so that a downturn in one sector does not threaten the entire business. Some middle market private equity firms pursue conglomerate strategies to build diversified portfolios.

Two related subtypes are worth noting. A market extension merger involves the same product sold in different geographies. A product extension merger involves different products sold in the same market. Both aim to broaden reach without building from scratch.

Additional types of M&A transactions

• Concentric acquisitions: Companies with different products, but similar customer bases, consolidate to gain an advantage in distribution, including increased cross-selling capabilities.

• Roll-ups: A strategy traditionally used by private equity firms but increasingly used by others including venture capital, buy-and-build entrepreneurs, and search funds, where a firm acquires a platform company and consolidates multiple businesses in the same industry into the platform company to achieve economies of scale and find cross-selling opportunities.

• Bolt-ons or tuck-ins: Where a private equity firm acquires one or more smaller companies and merges them with a larger, more established portfolio company. The acquired company or companies typically complement the offerings, products, or geography of the current portfolio company.

The private equity M&A

Private equity firms (or private equity sponsors) are a type of professional investor that often specializes in buying and selling companies through M&A, typically taking at least majority control. PE firms use their expertise in governance, finance, strategy, and execution to improve the performance of the companies they acquire, with the aim of later exiting their investment through a sale or IPO and generating (hopefully) a competitive return on capital for their investors.

Because of this investment strategy, management teams at PE portfolio companies can expect a hands-on, growth-oriented approach from the buyer throughout the lifecycle of the investment, including in the preparation and execution of the M&A deal.

While the deal structure and overall transaction timeline of private equity M&A will be consistent with the information in this article on other M&A deal types, a company being acquired by a private equity firm should be familiar with some additional considerations:

• Motivations and incentives: A PE firm is less likely to be a permanent home, because the firm will eventually need to exit its investment and realize a gain from the investment. Management of a target company should understand how the PE firm’s plans to accelerate growth and/or achieve operational efficiencies may impact the company’s long-term future.

• Capital structure: It is generally the case that the entire capital structure of the portfolio company is restructured in a private equity acquisition, including using borrowed money to finance the acquisition in a leveraged buyout.

• Changes in management: If the company’s existing management is staying in place, acquisition of a company by a PE firm is often a chance for existing managers to get liquidity for their holdings in the target company, while also retaining optionality to recognize the potential upside of a future exit.

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Why do companies pursue M&A?

Companies pursue M&A when the combined entity is expected to be worth more than the two businesses operating independently. This concept is called synergy, and it is the financial justification behind most deals.

The most common strategic reasons for pursuing M&A include:

• Market expansion: You acquire a company that already has customers, distribution, or brand recognition in a geography or segment you want to enter.

• Product diversification: You add new product lines to your portfolio without the time and cost of developing them internally.

• Capability acquisition: You gain access to talent, technology, or intellectual property (IP) that would take years to build on your own.

• Defensive positioning: You acquire a competitor or emerging threat before it becomes a larger challenge.

• Economies of scale: You combine operations to reduce per-unit costs across manufacturing, procurement, or administration.

What are synergies in M&A?

Synergies fall into two categories, and they are not equally reliable.

Cost synergies occur when the combined company reduces expenses by eliminating redundancies, consolidating systems, or negotiating better supplier terms at higher volume. Cost synergies are more predictable because they are based on known expenses. They are typically the first to be modeled in a deal.

Revenue synergies occur when the combined company generates more sales than either could alone. This can happen through cross-selling products to each other's customer bases, expanded market access, or bundled offerings. Revenue synergies are harder to predict and are frequently overstated in deal models.

The most common situations where M&A makes sense

While virtually all deals fall into one of the three basic M&A structures, every company’s situation is different, with implications for the founders’ motivation to sell and the leverage they have to negotiate a good deal. Here are some of the most common situations that result in an M&A.

• Fire sale: A fire sale can occur if the company has not gained traction in the market, burn rates are high, and options for additional funding look bleak. As a result, the company’s board and investors want the quickest way out, and founders may find themselves accepting a less-than-appealing offer for acquisition due to lack of other options.

• Pivot: Companies that achieve some degree of traction may still believe there’s a ceiling on how successful they can be. In these cases, founders may decide to pivot in a new direction—for example, targeting a slightly different market, or changing the product focus.

• Us or them: M&As can change the landscape, and companies don’t want to get caught on the wrong side. A growing, successful company may become an acquisition target of a larger company in its space—and may decide to sell so that the large company doesn’t acquire another, competing company and supercharge a rival.

• Too good to pass up: Even if a company is doing well and has no plans to sell, founders have a fiduciary duty to their shareholders to strongly consider a compelling offer when it comes in the door.

• Strategic deals: Pre-existing commercial or investment relationships between buyer and target can create strong price dynamics for founders. Because the buyer already knows the target’s executive team and has a clear view of how acquisition could help fuel their growth, they may be highly motivated to outright acquire the target.

How founders’ goals and life situations affect M&A decisions

An often-overlooked factor in an M&A deal is where founders are in their lives and careers, and what their personal and professional goals are. Here are some common stages of the founder journey, and how they factor into whether a deal gets done.

• Ready for the next adventure: After years of building and scaling a company, some founders are ready to move on. Next steps may vary: They could be eager to start another company, take a break, focus on investing, or focus on family. The common thread is that their passion is leading them in a different direction.

• Still hungry: The opposite can also be true—founders’ deep personal connection to the ongoing challenge of building their company makes them reluctant to sell. They started the company from nothing and brought it this far, and may be eager to continue to grow their company and less inclined to cash out—even for a solid deal.

• Ready to sell — with reservations: In cases where a founding team is joining the acquiring company as part of the sale, the post-deal dynamics are a key factor. Depending on the personalities and goals of the founders, these could be crucial issues in the decision to sell.

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The stages of the M&A process

So you’ve gone through your sell options, considered any offer(s) on the table, evaluated how selling fits with your company goals, and sorted through the dynamics with your board and investors. What happens next? Here’s a look at a typical M&A process:

Enlist the help of bankers

When companies decide to proactively seek to be acquired, the first two calls they generally make are to brokers (to help them shop the deal) and their law firm (to help them negotiate deal terms). The brokers, often investment bankers, will work with the target company to identify potential acquirers, strategize on how best to position the company as an acquisition target, conduct market analysis, determine a target acquisition price, and facilitate meetings with interested buyers. The law firm will help the target company understand potential deal structures, tax implications and market deal terms.

Intro meetings and pre-diligence

In your first meetings with potential buyers to discuss a deal, you’ll want to get a ballpark figure for the value of the offer to make sure it’s not a waste of everyone’s time. (This applies when the company is proactively shopping itself to multiple buyers; the valuation dynamics and timing are different in cases where there is one identified buyer that has approached the company, as in an asset sale or strategic deal.)

In these first discussions, the buyer will do some basic diligence on you and your company to confirm the buyer’s underlying assumptions about the target company are correct (the target will share some key details to add substance to your sales pitch, but this is not a full due diligence examination yet). During pre-diligence, you also will want to discuss any regulatory issues that may come up, and how seeking those approvals could affect the timeline or even jeopardize your deal.

Modeling deal outcomes

Carta’s scenario modeling allows you to visualize the expected payouts by shareholder or share class based on exit value, expected non-convertible debt, and preferential payment terms to any preferred stock. While this doesn’t replace an allocation spreadsheet or “waterfall” (prepared in accordance with the terms of the definitive agreement governing the terms of the transaction), you’ll be able to get an understanding of anticipated returns based on deal size. This information is key as you enter into term sheet negotiations, so that you understand your breakeven valuation.

In most cases, Carta’s scenario modeling and cap table management software can serve as the starting point in constructing the allocation spreadsheet so your business team, investment bank, or law firm doesn’t have to model from scratch.

For more information, see:

• Scenario modeling for companies on Carta’s corporations platform

• Scenario modeling for VC investors contemplating an exit for a portfolio company

• Scenario modeling for private equity M&A

Basic terms and letter of intent

Once you agree to move forward and align on basic terms, like the purchase price of the deal, it’s time for the buyer to present the target company with a letter of intent (LOI), which is the M&A equivalent of a term sheet. This document will likely say what kind of deal structure is expected (stock sale, merger, asset purchase) but this will be pending diligence. Sometimes the type of deal will change between LOI and signing, depending on what potential roadblocks or complications are uncovered during diligence.

Document drafting and due diligence

After the letter of intent breaks down basic terms of the deal, the lawyers will get to work drafting the full, detailed deal agreements. This is the stage of the deal where your outside lawyers will really take over. There will be further negotiation at this stage about the details of the deal. This takes a bit of time, and the diligence process will run in parallel.

Due diligence is a comprehensive review of the activities of a business, including financial, commercial, and capitalization matters. Due diligence in an M&A deal is typically the most time-consuming part of the process, given the information asymmetries that could result in a buyer assuming unknown liabilities in the deal. Also, the buyer could be taking on new stockholders or investors if buyer stock is to be used as consideration in the deal, so the buyer (and potentially the target) will want to diligence those new stockholders to understand who they are and the existing rights that they have in the target company.

M&A due diligence will be much more robust than the diligence experienced to date for a typical venture-backed company—think a diligence request list with at least 10 pages of categories, versus a two to three page diligence request list in a typical venture financing.

The goal for the buyer is to leave no stone unturned and to bridge the information asymmetry through a combination of diligence and robust representations and warranties in the transaction document. Sellers need to be organized and prepared for what may seem like endless document and information requests which can be challenging when trying to operate the business and work on other parts of the transaction (e.g., negotiating the transaction documents, working on employee transition plans, etc.).

Capitalization diligence

Capitalization diligence is a big part of the larger due diligence effort, so auditing your cap table before the M&A diligence process kicks off will save a lot of time and questions down the road. The buyer will typically review the target company’s cap table to “tie out,” or confirm the accuracy of, the ownership history of all past and present security holders.

Some common capitalization diligence problems that arise in M&A transactions include:

• Lack of documentation, or unexecuted documentation, for equity issuances—particularly to founders, early employees, and early investors

• Lack of proper or accurate approvals for equity incentive plan increases

• Failure to update the cap table for stockholder name changes or employee departures

• Options with a strike price not based on a valid 409A valuation report

• Failure to comply with Rule 701 disclosure requirements

Carta’s cap table reports can expedite the tie-out process, serving as the target company’s main repository of documents, valuation reports, equity award documents and stock ledgers. You may also need to prepare and assemble capitalization-related materials for a disclosure schedule, including equity paperwork, ledgers or full cap table reports that are attached as annexes to the disclosure schedule. All of these can be downloaded from the Carta cap table.

→ Learn how to download capitalization diligence materials from your Carta account

Financial diligence

The buyer and the target will be asked to share recent financial statements, with the target’s financials particularly scrutinized. Carta automates your expense accounting, including ASC 718 stock compensation expense reports that can be delivered to the buyer as part of diligence.

→ Learn more about financial reporting on Carta

Signing

Once the lawyers agree on a final draft of the document, it’s time to sign on the dotted line. But don’t pop the champagne quite yet—there are still a few more steps before the money hits your account.

Regulatory approval and financing secured

Some deals, especially larger ones or any involving a foreign company, may require approval by government regulators. Deals that could be considered to diminish competition in an industry will need to be evaluated for antitrust concerns. And deals with international companies will need to be evaluated by the Committee on Foreign Investment.

• Antitrust: Antitrust laws are designed to promote “vigorous competition” and protect consumers. Deals that consolidate a significant amount of market share may run into antitrust scrutiny. Your lawyer will advise you if the deal will need to be submitted to the FTC’s Bureau of Competition for antitrust evaluation. This process may change the timeline for a potential deal, so find out early on if approval is needed and plan accordingly.

• Committee on Foreign Investment in the United States (CFIUS): Any deal with a foreign company will need to be evaluated by this regulatory committee. Geo-political circumstances, like the relationship between the buyer’s country and the United States and its allies, will affect how likely the deal is to be approved. When evaluating a buyer, consider the global and political circumstances surrounding the deal.

Closing the deal

In a relatively small deal, signing and closing might be simultaneous or only a few days apart. For larger deals this can take much longer, especially if regulatory approval is required. If the deal is a merger, this point is when you file a certificate of merger with the state to make it official. And then you get paid.

M&A tax implications

Both the buyer and target should engage tax professionals to advise regarding tax structuring and tax implications of the transaction. However, there are also tax implications for most security holders of the target company if they receive a payout upon closing, resulting in potentially significant tax liabilities for rank-and-file employees, who may not be prepared for the out-of-pocket tax costs that result from that type of tax event.

The target company’s stockholders may have equity that is eligible for the qualified small business stock (QSBS) tax benefit, allowing them to exclude up to 100% of federal capital gains tax. Carta can help the target company and its stockholders determine what securities are eligible for the QSBS tax benefit.

→ Learn more about Carta's QSBS attestation letters.

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What happens after an M&A deal closes?

Closing the deal is not the end of the process. It is the beginning of the hardest phase. Post-merger integration (PMI) is the work of combining two separate businesses into one, and it is where deals are ultimately won or lost.

The key integration workstreams include systems consolidation, organizational restructuring, culture alignment, and customer and vendor communication. Each workstream involves decisions that affect your employees, your customers, and your operations. A thoughtful employee compensation strategy during integration can help retain key talent.

Many M&A deals may fail to deliver their intended value, and the primary failure point may be integration rather than the deal itself. You should build a detailed integration plan before closing, not after.

Common integration challenges include:

• Conflicting technology stacks that require migration or replacement

• Redundant roles that lead to restructuring and potential talent loss

• Culture clash between teams with different working styles and values

• Loss of key employees during the transition period

Looking out for your employees during an M&A

A merger or acquisition can have profound effects on employees, both when it comes to their equity and their life after the deal.

An exit event like a merger or acquisition is the moment when mostly-illiquid employee equity may result in a cash payout. In some circumstances, this can be a life-changing amount of money. But depending on the price of the deal, the company’s financial situation and how it compares to the valuation of the company when employees were issued equity, employees may see their equity value washed out in a merger or acquisition.

In any kind of exit or liquidation, consideration is generally paid out in the following order and not pro rata, meaning (for example) that #1 must be paid in full before #2 gets paid:

1. Debt holders 

2. Preferred stock holders (mostly investors)

3. Common stock holders (employees and founders)

4. Option holders

This structure is called the liquidation stack. Most investors hold preferred stock, and most employees (often including founders) hold common stock outright or resulting from the exercise of option grants. When considering the value of a deal and the scope of conditions, keep in mind that depending on the deal size, it’s possible that some people won’t make any money—including your employees and other common stockholders.

To ensure your employees have sound tax advice and understand the financial implications of the exit, Carta offers personalized tax advice for employees. Our equity advisory services include company-wide educational sessions and unlimited, confidential one-on-one sessions with a tax advisor.

→ Learn more about equity advisory services.

Post-deal

Consider life after the deal for your employees. How do the new owners plan to operate? How will your company be integrated into the parent company? Are the new owners planning to keep your team in place? (Because as much as your employees might want liquidity for their equity, they may want to keep their job even more).

Additionally, consider: How will the new company’s culture fit with the target company’s employee expectations? Will the new benefits package match the current offering (for example, how does the new company handle parental leave)? And what will be the new remote work policies?

These considerations directly affect your employees’ lives and will be uppermost in their minds.

Navigating the M&A process with Carta

Carta builds infrastructure for innovators along the entire journey, from inception to exit. With Carta, your cap table will be up to date and clean, making for a seamless transition in ownership. If you’re a Carta customer going through an M&A transition, customer support is standing by to help seamlessly offboard from one company and onboard to the new entity.

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Frequently asked questions about M&A

When should I tell Carta about my M&A?

Generally, the earlier we get involved, the better, so we can coordinate with external legal counsel on deliverables and offboarding (if appropriate). Notifying the target company’s customer success manager or Carta’s support team once the letter of intent is signed, and a proposed closing date has been set, can make for a smoother process as you move toward closing. This is particularly important in a stock sale or merger, when there are likely closing deliverables related to equity.

What happens to stock options during an acquisition?

Stock options are typically handled in one of three ways: accelerated vesting (all options vest immediately at closing), assumption by the acquirer (your options are converted into options in the new company), or cash-out (you receive a cash payment based on the spread between your exercise price and the deal price). Some employees may benefit from early exercise of stock options before a deal is announced. The treatment depends on the terms of the acquisition agreement and your company's equity plan. If you hold options, understanding the rules around exercising stock options is essential before a deal closes.

How long does an M&A transaction take?

Timelines vary widely. A private acquisition with a willing buyer and seller can close in two to three months. A public company merger involving regulatory review, shareholder votes, and multiple jurisdictions may take six to 18 months. Companies exploring alternatives to acquisition, such as dissolution or a public offering, should consider IPO readiness timelines as well.

How do dealmakers determine the enterprise value of a target company?

The value of a target company in M&A is typically determined by three methods: discounted cash flow (DCF) analysis (discounting projected future cash flows at the weighted average cost of capital [WACC]), comparable company multiples (EV/EBITDA from similar public peers), and precedent transaction multiples from prior deals. The DCF anchors intrinsic value but is assumption-sensitive, so the final number is a negotiated range where all three methods converge.

What is the difference between a stock sale and an asset sale?

In a stock sale, the buyer purchases the target's shares and inherits everything — assets, liabilities, contracts, and obligations. In an asset sale, the buyer selects specific assets and can avoid certain liabilities. The choice affects tax treatment, liability exposure, and whether existing contracts transfer automatically.

Why do most M&A deals fail?

The most consistent failure drivers are overpaying for the target, underestimating integration complexity, cultural misalignment between the two organizations, and weak strategic fit. Synergy projections may be overstated, and integration planning may start too late.

How long does M&A due diligence take?

Typically 30 to 90 days, depending on the complexity of the target business, the quality of the seller's records, and the scope of the buyer's review. Companies with organized financial statements, a clean cap table, and well-maintained corporate records can complete due diligence significantly faster.

What is a hostile takeover?

A hostile takeover is an acquisition where the buyer bypasses the target company's board of directors and takes the offer directly to shareholders. This is typically done through a tender offer (offering to buy shares at a premium) or a proxy fight (attempting to replace the board with directors who will approve the deal). The target's management opposes the transaction, but the buyer proceeds anyway.

What is a reverse takeover?

A reverse takeover (RTO) is when a private company acquires a publicly traded company — rather than the other way around — as a shortcut to going public without the cost and scrutiny of a traditional IPO. The private company effectively "becomes" the public shell by merging into it, inheriting its stock exchange listing. This is attractive because it's faster and cheaper than an IPO, though the shell company's existing liabilities and regulatory history can introduce hidden risks. RTOs are common when private companies want public market access quickly, often at the expense of the rigorous due diligence an IPO would require.

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