Companies merge to gain cost and revenue synergies. In addition, they can use M&A as a way to reduce their tax burdens.
Typically, the acquiring company buys the target company with cash or stock and assumes the acquired firm’s debt (if any).
Researchers studying M&A through an economic lens have looked at M&A motives, such as economies of scale and market power, and whether M&A improve performance.
History
The business of mergers and acquisitions involves the consolidation of companies or their major assets through financial transactions between firms. A firm may purchase and absorb another company outright, merge with it, make a tender offer or stage a hostile takeover to acquire it. In addition, a firm can also consolidate its major business assets by making a strategic investment.
Over the years, there have been many mergers that ended up being unsuccessful, with varying reasons given for their failure. For example, a merger may fail because of cultural differences, inadequate management or poor long-term planning.
The industry that has seen the most M&A activity is health care with more than 38’000 deals representing 14.2% of all transactions. The second most popular sector is the financial industry with 23’725 deals and a transaction value of 2’807 bil. USD. Other industries include technology with over 22’049 transactions and consumer products with 2’804 transactions. Most M&A activity is domestic, although there are some cases of cross-border deals.
Purpose
The purpose of acquisitions is to achieve strategic objectives, create synergies, diversify products or services, acquire talent, acquire assets at a discount, gain access to new markets, and generate a return on investment. During the third merger wave, acquisitions were more likely to involve companies in different industries. According to Aleksey Krylov, an experienced CFO with M&A experience, today, acquirers are more likely to buy into the same industry and select firms that complement their own product lines.
Economies of scale are a major reason for M&A, as the combined entity has greater bargaining power in terms of pricing and other business negotiations with suppliers. It’s also cost-efficient to combine businesses when they have similar production and distribution channels.
Entering a new market requires significant resources to set up production centers, purchase machinery and equipment, build storage places, and initiate distribution channels. M&A can provide the company with access to these resources more quickly and efficiently. Non-material resources are another benefit of M&A, as they can include specialized knowledge, technology or intellectual property, which can help the acquiring company achieve its business goals.
Structure
A merger involves two companies joining together in a legal entity to create an integrated business. The structure can be an asset purchase where the buying company purchases the assets and liabilities of the target business, an equity purchase where the buyer buys shares in the purchased entity or a reverse triangular merger where the target company merges into the buying company and then ceases to exist as an independent entity.
The acquisition method chosen has implications for the cost of the deal and should be reflected in financial modeling for the project. Assumptions regarding the acquisition method should be made such as tax treatment of share purchase versus asset purchase, cost-saving opportunities and integration costs.
The M&A process can be a daunting one and requires time away from the core business to conduct due diligence. The pressure to push deals through can lead to overpaying which can erode the profitability of an acquired company and derail future growth opportunities.
Value
Mergers and acquisitions can help businesses diversify revenue streams by acquiring companies that bring in different types of customers. For example, a beer company that acquires a winery may gain more revenue by combining their different client bases and distribution channels. This allows a company to increase market share and reduce their risks by spreading their business across multiple sources of income.
Other M&A reasons include achieving economies of scale, acquiring technologies that save years of research and development costs, and expanding into new markets. However, pursuing an M&A strategy without proper due diligence can result in overpaying for a deal.
Valuation is crucial in M&A, as it determines a purchase price and helps negotiate deals. This process involves analyzing financial statements and using valuation methods such as discounted cash flow analysis and comparable company analysis. By valuing a company’s worth accurately, M&A can be a smart way to grow your business. Engage with a seasoned CFO with M&A experience today!
