Yellow Knight

A company that originally attempted a hostile takeover, but later opted for a merger

What is a Yellow Knight?

A Yellow Knight is a company that attempts to mount a hostile takeover of another company but ends up instead discussing the idea of a merger with the target company. The change in strategy may occur when the targeted company resists the hostile takeover and the acquirer is forced to be friendlier in order to successfully negotiate a deal.

The reference to the color yellow indicates fear or cowardice. The former aggressor abandons its initial takeover strategy for fear that the strategy will fail and that it will have expended valuable resources in vain.

Yellow Knight

There are several reasons why a company may change tactics from a hostile takeover to a friendly merger or acquisition. The primary reason is usually just the probability that the takeover attempt will be unsuccessful. The target company’s resistance may be strong enough to quickly convince the potential acquirer that it probably does not have, nor can it access, sufficient resources to complete the takeover.

A company may also shift from a hostile takeover stance to that of proposing a friendly merger due to a change of circumstances at the target company. Events may occur, such as a natural disaster that destroys key assets of the target company. The acquirer may decide that a better use of its resources would be to assist the target company via a merger.

Faced with resistance from the target, the acquiring company may reassess the situation and simply conclude that a friendly merger is more likely to achieve positive outcomes for both companies.

Factors for a Yellow Knight to Consider

Once the acquirer drops the hostile takeover attempt and agrees on a merger with the target company, several factors should be considered to ensure that the new relationship is beneficial.

These factors include the following:

Financial Impact

The primary objective of the acquirer is to increase revenue and net profits. The acquirer should first analyze the Earnings per Share (EPS) to decide if its goal is feasible or not. Merging through a share swap between the companies can be either accretive or dilutive. An accretive merger, one which results in the new combined company’s EPS being higher than the acquirer’s pre-merger EPS, is generally considered the most favorable option since it indicates an obvious increase in value.

Whether the deal will be accretive or dilutive depends on the relative Price-to-Earnings (P/E) ratios of the two firms. The merger will be accretive if the P/E ratio of the acquiring firm is higher than the target firm’s P/E ratio. The means of financing the deal – with cash or debt – can also determine whether a deal is accretive or dilutive. Deals financed with cash are almost invariably accretive, simply because the possible income from cash will rarely be higher than the equity earnings derived from the new company.

However, dilutive deals are not necessarily bad deals. For example, the new combined company may simply take some time to realize the benefits of cost savings through improved efficiencies and economies of scale. A deal that is initially dilutive, evidencing a drop in EPS, may eventually result in a substantial increase in value for shareholders.


The acquirer should consider the value to be generated after the merger of the two businesses. The acquiring company should analyze and evaluate the possibility of a higher cash flow resulting from the merger, lower cost of capital, and long-term growth prospects. Ideally, the merger should result in an increased growth rate in productivity, sales, and customer acquisition.

The cooperation should provide a greater beneficial impact than the productivity of each company separately in various areas such as finance, operations, market power, employees, and tax incentives. This greater beneficial impact is known as synergy: the concept that the whole is greater than merely the sum of its parts. Synergy can be either operational – referring to reduced costs – or financial, referring to increased revenues or profitability.

Asset Sale and Stock Sale

Another factor to be considered is the asset sale versus a stock sale. An asset sale refers to the purchase of the target’s assets, while stock sale refers to the purchase of the target’s stock. Buyers tend to prefer asset sales while sellers favor stock sales.

Types of Mergers

Depending on the terms agreed upon by the two organizations, the structure of the merger can be classified in one of several possible ways. Merger classifications include a market extension merger, horizontal merger, conglomerate merger, product extension merger, or a vertical merger. The type of merger is determined by the purpose of the business transaction and the relationship between the merging companies.

A market extension merger is a merger that occurs between two companies dealing in the same or similar products but in different markets. The merger aims to expand the market base and create diversity.

On the other hand, a horizontal merger is the incorporation of two firms dealing in similar products and operating in the same market. The ideal result of a horizontal merger is a new, larger company that enjoys increased market share and reduced competition in the marketplace.

A conglomerate merger occurs between two firms dealing in unrelated business activities. These companies merge to extend their respective markets and product lines.

A vertical merger is an integration between the acquiring company which relies on the products and services provided by the target firm. An example of a vertical merger is one between a manufacturing company and a supply company, increasing the efficiency of the supply chain which, in turn, increases profitability.

Benefits of a Merger

One of the benefits of a merger is the potential for an immediate growth without the need to start a business from scratch. A good foundation for cutting the cost of capital and increasing the rate of growth and returns is established.

One company may seek to merge with another company for any of the following reasons:

  • Improved profitability
  • Company growth
  • Acquisition of assets
  • Expansion of markets

Merging two companies usually provides access to a larger customer base, often through gaining access to new markets. For example, the merger of German car manufacturer Daimler Benz and American car manufacturer Chrysler Corporation gave the merged firm access to both the US and European car markets.

While takeovers can be ultimately profitable whether friendly or hostile, a cooperative merger can often offer the greatest benefit to both parties. Therefore, the transition from hostile acquirer to yellow knight is frequently an instance of good fortune.

Thank you for reading CFI’s explanation of a yellow knight. To learn more about mergers and acquisitions, we recommend the following free CFI resources:

0 search results for ‘