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A Simple Guide to Maximizing M&A Value Creation
Eric Allison
OCTOBER 2, 2019
The terms “mergers” and “acquisitions” are frequently used interchangeably. On the contrary, the two terms are distinctive. Acquisition happens when a company takes over another and labels itself as the new owner. Conversely, a merger refers to two entities of the same size who conjoin and move forward as a single company, rather than stay separately owned and managed.
In the ever-changing world of mergers and acquisitions (M&A), value creation has never been more important in recent years due to the growing industry trends and opportunities, technological disruption, and the need to shift to new business models to stay competitive.
In 2017, the global M&A market lost its firm standing compared with 2016. However, in 2018, the market grew and remained strong, with public transaction volumes reaching $4.1 trillion. It was the third-highest year for the M&A industry. Research also shows that the larger companies get, the more they use M&A to grow shareholder value.
A study shows that M&A transactions offer positive abnormal returns for businesses and shareholders. Professional staffing organizations in industries like IT, digital/creative, and healthcare, among others, continue to see rampant demand from buyers and investors.
Improving cash flows, establishing firmer balance sheets, reducing debts, and positive global growth—these are some of the key drivers of M&A, which contribute to overall profitability. Let’s take a deep dive into how businesses can get the most out of value creation during M&A transactions.
Maximizing Shareholder Value
Mergers and acquisitions aim to grow an entity’s reach and expand their operations. With the right vision and execution, M&A could be a quick way for businesses to enter new markets. It can also be an effective strategy when looking to maximize value for shareholders.
Mergers affect shareholders for both entities, and it manifests in different ways—for instance, the changes in the value of stock prices. The stock price of a freshly merged company is predictably higher than the acquiring party and the target company. Shareholders of the acquiring side often see a brief drop in share value leading to the merger, while shareholders of the company being bought see a spike in share value during the interim.
Likewise, M&A executed with the wrong vision may negatively impact the shareholders’ value. Case in point, the Bank of America’s acquisition of Countrywide Financial and Merrill Lynch saw their stocks plummeting down south after their M&A transaction. Reason being, the three companies’ cultures didn’t mesh together.
The end goal of mergers and acquisitions should be to generate (and maximize) value to shareholders and retain a healthy and robust company. If you see your company undergoing either a merger or acquisition in the future, make sure that you have a clear vision, and that the company you’ll be working with aligns with your core values and culture as a business.
Maximize M&A Value Creation with Synergies
Synergies from the M&A perspective refer to when the combined value of the two companies that merge exceeds the separate individual value of the acquirer and the target. That being said, it is expected that the integration can lead to value creation generated through synergies between two entities.
Achieving synergy is the goal of every M&A transaction. These are essentially the only reasonable grounds for acquisition because they constitute the additional value that can be obtained in the acquisition process. That is, when the acquirer purchases the target for a reasonable cost. A successful M&A transaction starts with a plan that will facilitate those synergies. Seeing those synergies materialize from day one of the process signals successful integration.
Three various types of synergies may spring up in mergers and acquisitions transactions: cost, revenue, and financial. Let’s see how each factor influences value creation during the M&A process.
Cost synergies refer to the opportunity of minimizing overall costs as a result of two companies combining, which consolidates operations and creates economies of scale. Cost reduction is the highlight of this type of synergy since even if the rate of the revenue does not rise, the costs would still be reduced, and profit would increase.
Potential sources of cost synergies are lower staffing and salary costs since merged entities won’t need two people for each position (i.e., two CEOs or CFOs, etc.), reduced rent, reduced professional services fees, and consolidating suppliers or renegotiating supplier terms, among others.
Revenue synergies occur when two entities combine and as a result, can sell more products and/or services or gain market share together as opposed to when they were separate companies. For instance, if Company A, who had revenue of $300 million, integrate with Company B, who had a revenue of $70 million, they’re combined revenue is expected to rise to $400 million, which implies revenue synergies of roughly $30 million.
Revenue opportunities of this type are access to new markets, sharing of distribution networks, improved sales and marketing, better pricing power, adoption of the cross-selling strategy, and supply chain efficiencies.
Finally, financial synergy in M&A transactions refers to when two entities integrate to establish financial advantages they wouldn’t otherwise be able to achieve individually. This is highly beneficial for mid-sized companies. Moreover, merged entities are usually granted more tax breaks and tax reductions than they had as two formerly separate companies.
For instance, when a mid-level organization borrows a loan from a bank, they might get charged with higher interest. But if two mid-level companies integrate and as an outcome, they become a large company that borrows a loan. They will then receive lower interest rates in acknowledgment of a more efficient capital structure and a balanced cash flow to support the loan.
Value Creation for the Owner Upon Exit
Mergers and acquisitions transactions often highlight the triumphs of buyers or investors. From a seller’s perspective, about 42% of divestors stated their last sales generated value. In reality, business owners who decide to cash out and surrender to the full acquisition of their company can get value out of exiting as well, especially if you’re selling to a strategic player who has the right vision and plan for implementing the acquisition.
“Selling out” isn’t necessarily a wrong business move. One of the well-known benefits of selling is it provides immediate total liquidity. This is a far better option compared to IPO (Initial Public Offering), where founders are usually subjected to lock-ups preventing them from selling shares for a time, and with shareholder liquidity set aside to prioritize growth.
Standard M&A deals are faster, less laborious, and less expensive as opposed to going for IPO. This covers the negotiation of terms followed by three to six months of due diligence.
The reasons that motivate a business to sell can vary. Perhaps it’s due to a competitor offering an unsolicited yet highly rewarding offer, the founder is ready to dip their toes into other ventures, or perhaps they’re simply ready to retire. Involving your business in mergers and acquisitions transactions can be a great option when the time comes and you’re prepared to sell your company.
It’s been a highly eventful year for M&A in several key areas. In the staffing industry alone, it was reported that 33 M&A transactions transpired in the first quarter of 2019. It’s always better to ride the robust cycle when it’s red hot. However, make sure to build a solid exit plan for at least 3-4 years ahead of your sale. You’ve spent years investing in and growing your business; you must do the same when it comes to selling it.
Summing It Up
The bottom line is, value creation should be a priority during M&A deal processing. Businesses should carefully look into the negotiation terms and integration risks to certify that the transaction is a win-win for both parties, whether it be a merger or a full acquisition. M&A should lead businesses to maximize value creations to achieve maximum synergies.
In the global corporate marketplace, mergers and acquisitions are commonplace. You’ll hear news and stories about a big company acquiring small businesses or entities merging to cement their place in their respective industries. But that’s not all there is to it. Companies should also aim for revenue growth and cost reduction, leading to better financial performance.
Are you looking into a business merger or acquisition in the future? You might want to reach out to a reliable M&A consulting team to help enlighten your objectives and introduce you to firms whose values, business culture, and strategies align with your own company. This way, you can ensure your partnership is successful and worthwhile.
This article was originally published on the Golden One Ventures Blog: Maximize Mergers and Acquisitions Value Creation
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