Are you keen to expand your business quickly? Discover five great ways to do this by buying another company, otherwise known as an acquisition.
In this guide, we take a quick look at different types of acquisition and the key factors to consider.
Contents:
What is an acquisition?
An acquisition is where one company buys the assets or the shares of another. The company being bought (the target) is either dissolved or becomes a subsidiary.
Here are some reasons why you might consider an acquisition rather than relying on organic growth to scale:
- You feel you could add value to a company by improving its performance and thereby make a profit, either by selling it or keeping it as a subsidiary
- You want to eliminate a competitor and increase market efficiency
- You’d like to get hold of another business’s assets such as its staff, IPR, equipment or property
- You’d like to get or improve your access to another market sector or location
- You see a synergy with another company’s products or services that you feel you have the skill to develop more quickly than the target could
What’s the difference between a merger and an acquisition?
Unlike an acquisition, a merger more closely resembles a strategic alliance of two companies. The goal of a merger is to create a new company that combines the best of both businesses. Mergers are generally ‘friendly’ – that is, they are consensual arrangements designed to enable both sides to profit from the deal.
In acquisition, however, one company buys another’s shares or assets. Sometimes these transactions are known as ‘takeovers’, where a dominant business takes over a smaller or less successful one.
As mergers and acquisitions can often be quite complex, the term M&A is coming to mean any transaction where two businesses are consolidated. Read our article on the seven different types of business merger to consider for you business.
Different types of acquisition, their advantages and downsides
Asset acquisitions
In an asset sale, the buyer takes over certain assets belonging to a target business. The types of assets bought can include IPR such as trademarks or patents, business contracts, freehold or leasehold property, plant or machinery, goodwill and stock.
The key advantage of an asset sale is flexibility, as the buyer can pick and choose which assets to buy and decide whether to assume any liabilities connected with those assets. In a share sale, the buyer will take on all the target’s assets and liabilities automatically. In addition, it’s unlikely that the seller’s shareholders will have to agree to the transaction.
Another advantage of an asset sale compared to a share sale is speed. Since the buyer won’t be taking over liabilities automatically, the due diligence process is likely to be quicker.
There can be certain tax advantages with an acquisition, providing the buyer with allowable losses to set against gains or profits.
The downsides of share sale are these:
- Often third parties will need to consent to an asset sale, for example, landlords, customers and sometimes shareholders. This process can delay or scupper a sale
- Customers may decide to terminate their contracts rather than have these tranferred to the new buyer
- The Transfer of Undertakings Regulations (TUPE) may mean that the seller’s staff transfer automatically to the buyer
Share acquisitions
In a share purchase, the buying company acquires all of the seller’s shares. In so doing, they automatically take over all the seller’s assets and liabilities and become the new owner.
Here are the advantages of a share sale:
- There can be tax advantages associated with a share sale, including entrepreneurs’ relief on any capital gains, roll-over relief, a single (and therefore simpler) chargeable gain etc.
- The target company stays in business after the sale, contracts don’t need to be assigned as they transfer automatically, and you don’t need to get the consent of third parties such as landlords
However, share sales tend to be more complex than asset sales, and the buyer will need the seller to provide it with warranties and indemnities against hidden risk – these can be tricky to negotiate. Due diligence will be more intensive as the buyer will need to investigate all potential liabilities that may emerge over time. Plus, the buyer will automatically take over all the seller’s staff on their existing terms and conditions.
Related to this last factor is the risk of conflicting corporate culture. A failure to ensure all employees work well together and are happy with the acquisition may cause reduced motivation among employees. This can reduce the productivity of your business and may also lead to employees leaving. Managing the expanded business whilst also ensuring consistency in culture and employee satisfaction may be a barrier to a successful expansion
Conglomerate acquisitions
A conglomerate acquisition is where one business buys another that’s operating in a completely different market, either geographically or in another sector. Because each operates in a separate sector, they weren’t in direct competition. Following the acquisition, the buyer and seller can now share assets, enjoy access to the other’s markets and customers, and make efficiencies or diversify.
The disadvantage of conglomerate mergers is that it may be too tricky to combine effectively the two, unrelated businesses.
Leveraged buy-outs
A leveraged buy-out is where a company borrows money to fund the cost of acquiring a business, often securing those loans with the assets of the target company. The ratio of debt to equity in an LBO is often around 90/10 debt/equity.
The main reason you’d choose an LBO is to acquire an existing, successful business without risking your assets. You can repay the loans from the future cash flow of the business being acquired. The downside of an LBO is the high level of indebtedness that results, and the consequential drag on cash flow.
Management buy-outs
A management buy-out is where the management team of a business buys the company from its existing owners. An MBO is typically also an LBO; that is, funded by borrowed money.
The objective of an MBO is often to improve the company’s performance and make efficiencies. The management feels that they are in a better position than the current shareholders to grow the company. Through an MBO, they’ll have greater control over the business and the way it’s run. They’ll also have more flexibility over their own pay and rewards.
The downside of an MBO aside from the extra indebtedness is that sometimes managers find the transition from worker to owner a difficult one. In addition, managers may be faced with a potential conflict of interest when valuing assets involved in the transaction.
Key factors to consider in an acquisition
If you think an acquisition could be a good option for your business, what aspects of the deal should you consider?
Here are some things to think about before you take the plunge:
- Is the target company a good strategic fit? Are you confident that you can manage the disruption caused by the deal, and in the rationale for the purchase?
- Make sure you do thorough due diligence before you sign, and make sure you know exactly what you’re taking on
- Be prepared for a lengthy transaction and potentially protracted negotiations
- Introduce yourself to the management team of the target and get to know their strengths and weaknesses
- Develop an integration plan with milestones
- Consult with staff and keep them informed about progress
- Study the financials, the business plan and market data
How can companies choose the most suitable acquisition type for their goals and circumstances?
After you’ve figured out your acquisition strategy, the next move is to identify the target that’s the best fit for that strategy.
The purchase price will be a key factor, especially concerning the company’s assets and its existing debt. If the business is paying high interest rates, you could use your better leverage to refinance, but a large ratio of debt to equity on a company’s balance sheet is not a good sign.
In addition, and as part of your due diligence, make sure that the company doesn’t have pending or threatened litigation. Take note during diligence of how well the company seems to be run and managed. Inefficiency can be reduced to increase profits, but poor record-keeping is rarely a good sign.
For more answers to commonly asked questions and advice on mergers and acquisitions, consult our mergers and acquisitions solicitors. Get in touch on 0800 689 1700, email us at enquiries@harperjames.co.uk, or fill out the short form below with your enquiry.
