In the business world, acquisitions are generally associated either with growth or a lack thereof. If your business is looking to expand, acquisitions (implemented with a solid acquisition strategy) can be a powerful and effective way to achieve that. However, acquisitions are a complex process complete with many legal, financial, and business details to sort out along the way. There is so much to cover, in fact, that we have written about them before.
In this article, we will review some of what we have previously covered regarding the basics of mergers and acquisitions, as well as how to go about creating them successfully.
We will then delve even deeper into acquisitions, especially with regards to
- how they differ from mergers and takeovers
- how they relate to the business valuation process
- different acquisitions strategies
- benefits and drawbacks to the acquisition process
What is an Acquisition?
First, let’s define “acquisition.” An acquisition occurs when a company purchases the majority of another company’s shares, thus gaining control of that entity. The threshold is a simple 50% of shares, giving the buying company with at least 50% of the shares the power to make decisions about the company they have purchased without needing the approval of other shareholders.
Understanding Your Options
So what is the difference between an acquisition, a merger, and a takeover? Without any context, the definition of an acquisition sounds a lot like a takeover. The distinction lies mostly in the details and specific circumstances of each individual deal.
Acquisitions are typically fairly amiable transactions. The target company has agreed to be acquired, sometimes the deal even benefits both companies, and there is a period before the acquisition where both companies review financial statements, valuations, and agree on the legal terms of the acquisition.
Takeovers, as the name implies, are much less amicable. A takeover occurs when the target company has not consented to the acquisition; as you can imagine these transactions can often be hostile. Since there is no agreement or reviewing of legal and financial matters leading up to the target company’s purchase, the purchasing company achieves the acquisition solely through buying enough stakes in the target company that they gain control and force the acquisition.
Mergers are a whole different story. In a merger, one company does not acquire another company — instead, two companies come together to form one new company. There are typically fewer power dynamics at play in a merger; the companies involved are usually similar in size and scale, and the merger benefits them close to equally.
Reasons to Conduct an Acquisition
Now that we have covered the basic differences between acquisitions, mergers, and takeovers, let’s delve into why a company might want to conduct an acquisition. It is hard to answer this question without first touching on business valuation.
If you recall, our last article reviewed business valuations— what they are, how to go about them, and what they’re used for. As it turns out, one of the main things they are used for is acquisitions. Any company involved in the acquisition process should complete a business valuation.
It is virtually impossible to complete an acquisition without first having a clear understanding of what both businesses involved are worth. This is exactly what a business valuation will tell you. You have to know what the companies involved are bringing to the table to agree on the legal and financial terms that will lead to a lasting and successful acquisition.
Business valuations can also be incredibly helpful tools for companies deciding between various acquisition targets; reviewing the valuations of your different options will go a long way to helping you make an informed decision.
Ways of Achieving Growth Through Acquisitions
With that in mind, let’s move on to discuss the various reasons that companies choose to undergo acquisitions. The main factor at play when companies buy other companies is growth: the company purchasing the other company wants to grow. But the types of growth and ways of achieving growth can be very different.
1. Reduce competition
One very common way to grow— and thus a reason to complete an acquisition— is through reducing the competition. You do this by purchasing a company that produces a similar product or service. Oftentimes a company will acquire another company that is a competitor of theirs, thus improving their economies of scale and gaining a larger share of the marketplace.
2. Purchasing suppliers
Similarly, acquisitions will sometimes be between a company and one of its suppliers. By purchasing a supplier, a company can take steps towards streamlining their product line, production, and operations, thus increasing their efficiency. Again, this improves economies of scale and supply chain functionality.
3. Eventual increase in cash flow
And of course, the promise of an increase in cash flow is the biggest reason that companies are tempted by potential acquisitions. It is also the most obvious choice in terms of growth. Sometimes there is a slight lag period post-acquisition while the company figures out how to best manage their new investment.
However, the company should see all sorts of benefits if the acquisition was done successfully.
Benefits such as
- reduced redundancies
- increased efficiency
- a larger share of the market
- greater access to production supplies
- an even a larger social media presence
All of these things should lead to increased cash flow, varying between short and long-term returns.
The Drawbacks of Acquisitions
Like anything, there are also drawbacks to acquisitions. And since completing an acquisition is such a time-consuming process, the drawbacks can be fairly substantial if the acquisition is not conducted properly.
The most notable drawback is that acquisitions can be very expensive. For the reasons noted above, a successful acquisition can be well worth the money put into it, but it is definitely worth thinking long and hard about the benefits before jumping in.
Acquisitions get expensive the fastest when they err on the side of takeovers. The price for the purchasing company tends to shoot up, if the target company does not want to be— or is even hesitant about being— acquired. And that’s without taking the legal fees into account.
This is another good spot to mention the importance of business valuations — make sure that you are well aware of the valuation of the companies you are considering acquiring. A thorough valuation will help you determine if the investment will be worth it in the long run.
We mentioned legal fees above— the legal side of business acquisitions tends to be incredibly arduous. It can be a reason to strongly consider whether or not an acquisition is worth your time and money. Even the smoothest acquisitions require a substantial amount of legal paperwork, discussion, and fees.
Make sure you have the resources to devote to that from the beginning. But the more complicated and hostile the acquisition, the more complex, time-consuming, and expensive the legal matters become.
Acquisition Strategy
The last thing we want to talk about is the concept of an acquisition strategy. We have discussed different ideas, benefits, drawbacks, and concepts behind the acquisition process above. A solid strategy is what brings it all together.
Essentially, an acquisition strategy refers to the process and method by which the purchasing company goes about acquiring a target company. A successful one should place a company in the position to reap all the benefits of acquisition and avoid the drawbacks.
What To Consider While Building an Acquisition Strategy
As discussed, acquisitions can be incredibly complex. For this reason, companies considering acquisition want to have an extremely well-outlined plan and protocols to follow once when they ultimately embark on the process.
This should include a well-thought-out plan for exactly how this acquisition will benefit the company in the long term. It should also cover how it will positively impact the company’s growth. This plan should be specific and discuss how the business valuations of each potential acquisition target will translate into growth and increased cash flow.
There are several main strategic positions, or rationales, that are behind successful acquisitions. If you are considering an acquisition, make sure that the reason for it falls under one of these umbrellas:
- Consolidation within an industry
- Faster and cheaper access to necessary skills or technology
- Identifying smaller and newer businesses and acquiring them (thus being a part of their development and growth)
- Consolidating a fragmented market in order to achieve economies of scale (known as a roll-up strategy)
These are a few examples of the more common positions behind acquisition strategies. There are more strategic positions that can be quite successful, but they are generally rarer and can require even more expertise than what’s listed above.
Let’s Build An Acquisition Strategy Together
Since this process is so complex and requires so much specific business knowledge, we highly recommend you bring on a professional to assist with your acquisition journey.
We at Saddock Advisory are highly skilled at assisting in business acquisitions and developing acquisition strategies. Our team has been helping our clients, business leaders just like you, solve problems and customize solutions for nearly four decades. We are here to help you understand and benefit from acquisitions.
So, if you’re ready to craft insights and strategies that go beyond numbers, get in touch with us today!
Sources:
https://www.accountingtools.com/
