Even for the savviest financial and business professionals, the merger and acquisition process can be grueling. It is so detail oriented, and filled with potential legal, financial, and business complications throughout. If done correctly, though, with significant forethought (and afterthought) completing a successful merger or acquisition can have the highest ROI for your company. Today we’ll talk about mergers and acquisitions, their benefits and drawbacks, and the basic steps of the process.
Basics of Mergers and Acquisitions
The merger and acquisition process, commonly referred to as M&A, refers to the joining of two businesses. A merger is when two typically similarly sized businesses join forces.
Meanwhile, an acquisition refers to one company buying another, and thus folding its operations into their own.
Differences between Mergers and Acquisitions
Mergers are typically between two similarly sized companies which decide to join forces. They each combine their unique positive attributes to make one stronger company. Usually, this on good terms and the companies become equal partners in the deal.
However, acquisitions happen when one company buys another and folds it into its operations. These can be friendly or hostile, depending on the situation.
Steps in the M&A process:
- Develop an acquisition strategy
- Clear idea of what the buyer expects to gain
- Set the M&A criteria
- Search for potential targets
- Begin acquisition planning
- Valuation analysis – target company provides substantial financial information
- Due diligence – happens after the offer is accepted, attempts to confirm or correct the buyer’s assessment of the value of the target company
- Purchase and sale contract
- Financing strategy for the acquisition
- Closing and integration
Benefits that Come with Mergers and Acquisitions
It is not difficult to imagine why companies might be interested in M&As. When done correctly they hold tremendous potential for increased revenue and decreased competition, among other benefits.
We’ll now go over those benefits in extent. After all, it is far too arduous of a process to go through if you do not have a clear idea of what exactly your company stands to gain from it.
One of the biggest benefits to the buyer in an M&A is that they have likely eliminated a competitor from the marketplace. Yet, this is not always the case. Sometimes the buyer will acquire a business that functioned as a supplier or a customer to them, namely, a vertical integration.
But when the buyer acquires a competitor – a horizontal integration – they have captured a larger share of the market than they previously had.
Vertical integration can be quite beneficial as well, though. By acquiring a supplier, companies oftentimes are able to achieve more efficient supply chain processes. And this can be greatly beneficial in terms of operations and cash flow.
In a similar vein, a successful merger or acquisition will enable the new company or buyer to increase the speed and efficiency of production. With increased supply chain efficiencies, customer contacts, and more, companies will discover new ways to market their goods and services.
And this brings us to discussing a larger pool of staffing expertise – because the question of staffing is a big one in the merger and acquisition process.
The potential for reduced labor costs can be a drawback to the M&A process for the seller. Depending on the type of deal that is struck (merger vs. acquisition, horizontal vs. vertical integration, etc.) the buyer may be looking to eliminate staffing redundancies that occur as a result of the merger.
Of course, this does not always mean that the selling company will face layoffs, but it certainly can. On the other hand, this is a benefit to the buyer, because they have a larger labor pool to pick and choose the best possible combination of skill sets from. This almost always results in reduced labor costs.
Increase in cash flow
And then there is the most obvious – and usually the most important – benefit: increase in cash flow. This is a multi-faceted benefit from the perspectives of both parties.
For the seller, they receive the obvious benefit of cashing out their investment in the company, which oftentimes results in a big pay day. In some cases, they also receive the added benefit of reducing or eliminating the risk they have put into their business.
In the case of a merger, both parties typically achieve the benefit of saving costs. Naturally, when you take two companies conducting similar operations and combine them, opportunities will arise to save money, reduce redundancies, and increase efficiencies, and costs will be lowered moving forward.
Part of the way in which costs will be lowered is through the opportunity to obtain improved economies of scale. When two companies merge they typically will require more raw goods to make their products, and goods purchased in larger quantities are usually available at a lower cost.
The new company will also have an increased share of the market as a result of the M&A, which of course will lead to increased revenue.
And lastly, the financial resources at the disposal of the buyer will be greater. Being able to draw from the resources of both your company and your target company opens up wealth of financial resources.
Potential Drawbacks that Come with Mergers and Acquisitions
It would only be fair to enumerate some potential drawbacks to M&As as well. We have already mentioned a few, but several other issues can arise when a merger occurs without the proper due diligence being carried out.
The most notable potential issue with M&As is the cost. Acquiring another company isn’t cheap. If it’s a good deal, the expense can be well worth it, but if it’s not a good deal, the buyer can find themselves in a financial hole.
This situation tends to come up especially when the target company does not want to be acquired. When this is the case, the buyer oftentimes has to pay a higher purchase price than they would otherwise. And more issues, including legal ones, arise along the way, often costing more money.
Many of the issues that tend to come up during M&A deals with companies that don’t want to be acquired center around legal disputes.
When a business does not want to be acquired, but is being sought out, there are many steps that they can take to try to avoid the acquisition. The business could drag the process out so long that the buyer drops the deal, after wasting time in pursuit.
Or the buyer might end up spending so much money fighting legal battles that the acquisition does not make financial sense for them anymore. This is a point in case for why you should only enter into an M&A transaction if you have done your research, have the working capital, and are absolutely sure of what the process requires.
Not waiting for a better opportunity
Another potential negative is that when you travel too far down the road of an M&A transaction, you may be giving up other desirable deals. This is yet another argument for doing your due diligence and being one hundred percent certain of what you are getting your company into.
If there are several desirable M&As on the table, make sure that you have heavily vetted each and every option before you narrow your focus to just one. If you are not confident that the company you are going into business with is the best option, you may regret it in the long run.
Something else to consider before closing any M&A deals is how the public will view your deal.
Different businesses have varying degrees of public exposure, of course, but it is still worth considering.
For some companies, making a few minor mistakes throughout the M&A process can lead to significant negative public perception.
Sometimes your client base may have an overwhelmingly negative reaction to a company that you’re considering merging with. And this would lead to potentially losing customers if you go through with the deals.
These are all data points to make sure you research and have an understanding of before going too far down one specific path.
Mergers and Acquisitions Require Strategic Planning and Expert Help
All of this is to say that M&As can lead to lucrative, dynamic, and successful companies – when they are done correctly. But they are nonetheless complicated.
They usually involve:
- investment bankers
- private equity firms
- approval from shareholders
- extensive valuations and negotiations
- financing strategies
- legal battles and so much more
And when they are unsuccessful they can pose major problems for all parties involved.
Unsuccessful M&As can destroy a company’s value, which is especially bad for the buyer. Things like poor follow through on important documents, mismanaged integrations, and inflated ideas of potential cost savings can destroy an M&A.
On the other hand, if you take the time to go through the process the right way, an M&A can be the best thing that has ever happened to your business. This means starting out with a merger or acquisition strategy: knowing exactly what the buyer is looking to gain from the process and setting criteria. It also means searching for potential target companies and taking the time to run valuation analyses for each one of them.
Obviously, plenty of time is needed for negotiations, ensuring that the buyer’s assessment of the company’s value is accurate, and having an effective financing strategy. When all of these steps (and likely many more) have been undergone with due diligence, it’s probably time to close the deal and integrate the two businesses.
All this to say, strategic planning is crucial before taking the first step. Here is a recent blog discussing why hiring a consultant firm is a good idea for not only strategic planning, but also mergers and acquisitions.
We Can Help
There is so much more to talk about when it comes to working with a financial advisor, and that’s why our door is always open. We know it’s hard work to own business, and we’re here to help. Our trusted team of business financial advisory experts are ready to work with you to figure out the best plan for your business.
At Saddock Advisory, we can help determine if your business is financially healthy. Get in touch with us here to find out more.