One way of scaling your business overnight rather than through organic growth is to buy another company. This can be a winning strategy, but there are some drawbacks, not least the danger of paying too much for the target company
This guide will help you decide if a merger or an acquisition (M&A) is right for your business and show you what to look out for in a potential target.
Contents:
What’s a Merger and Acquisition?
The term merger and acquisition or M&A is where one company takes over another. This can be friendly (you both agree to merge) or hostile (where a rival company buys their competitor’s shares to gain a controlling interest).
Here are some examples of M&As and the terminology used to describe them:
- A horizontal merger. This is where two similar businesses join, for example, two soft drink manufacturers
- A vertical merger. This is a merger between two companies in a supply chain, for example, a food manufacturer buys a packaging company
- A conglomerate merger. This is the merger of two industry heavyweights in different industries, for example, Amazon and Whole Foods
- A concentric merger. This is where two companies in the same sector but offering different services merge, for example, a manufacturer of gaming hardware buys a game developer
Why might an M&A be right for my business?
Tax reasons
Here are some ways you can structure an M&A to save on tax:
- If you buy another company’s shares, you may be able to set off their tax losses against your future profits
- If you’re buying a company’s assets rather than their shares, you may be able to claim capital allowances for the plant and machinery and get tax relief on assets like intellectual property rights (patents, trademarks, etc.)
Economies of scale and synergies
Larger companies often get better deals from their supply chains than smaller ones, for example, better interest rates on loans and bigger discounts on goods and other assets. An M&A may give you access to more cost-effective machinery driving down your marginal costs, or you may save money on office or warehouse space by combining locations.
At the management and HR level, an M&A can reduce duplications in teams and skill sets, reducing personnel costs. Or, you may get access to a new sector or customer list.
You can read more about different types of synergies in our M&A FAQs.
Access to talent
One way to access specialised workers or skill sets that are in short supply is by a takeover.
Sector domination
By gobbling up smaller competitors in a single market, a single operator can gain traction in their sector by acquisition rather than organic growth.
This is why Facebook acquired Instagram – Facebook felt that it didn’t have enough users on smartphones rather than desktop computers so it bought Instagram enabling it to capture this market more quickly.
What are the downsides of an M&A?
Competition issues
Some mergers are deemed to be bad for competition. If two rival businesses merge in a single sector, the resulting single company could dominate the market leading to higher prices, or a bad deal for suppliers and consumers overall. For example:
- A company might impose unfair terms on its suppliers or buyers, such as exclusivity
- A single business may raise prices too much, or even drive them to force out competitors (think Amazon charging less than cost price for nappies, forcing out a competitor nappy business)
- A company might deny a competitor access to essential facilities, forcing them out of business
- Forcing customers who buy one product to buy another
If you’re considering a merger that would give you 40% or more of the share of a given market, you should take legal advice. If your business is guilty of abusing your market position, this can lead to fines and restrictions on your trade.
Cultural differences and clashes
A great company culture is good for team morale and leads to increased productivity. Conversely, an M&A can drag productivity as the company culture may be negatively affected by the deal, however hard you try to sell it to the teams.
Also, you may need to change employee terms and conditions, leading to staff grievances and high turnover.
Integration problems and operating delays
Bigger companies aren’t always more efficient than smaller ones, despite the potential for economies of scale. Larger firms tend to be more bureaucratic, slowing decision-making and general agility.
It can also be hard to integrate two businesses, for example:
- Combining systems and processes can lead to errors and duplications
- You will need to align the management teams in terms of strategy and objectives
- Bigger companies are administratively more complex and costly to run
- Different production lines or software incompatibilities can prove expensive to sort out
These potential problems can negatively affect productivity and customer satisfaction.
Paying too much for the target business
It can be tricky to value a company, and we’ve written a guide on how to evaluate a company for acquisition that looks at some of the issues.
There are certain common reasons you may overpay for a business: Over-estimating its core value, not following valuation best practice, and under-estimating integration costs.
For example, Nokia was a runaway success in the early days of mobile phones, producing user-friendly designs that customers loved. In contrast, Microsoft was lagging in its development of mobile-led products and saw an easy way into the market by buying Nokia. However, the resulting jointly developed phone was unsuccessful and Microsoft lost $7.6bn from the deal.
A failed M&A may jeopardise your future success
For the best chance of a successful M&A, you should bake into the deal a sufficient margin of time and costs. Spend too much time or too little effort on integration, and you may feel the impact for a long time.
Plan to stay hands-on during the post-implementation phase, and don’t delegate too much to your team. Keeping a high leadership profile is one way to avoid the culture clashes that can set in once teams merge.
Another reason that failed M&As can cause damage is to your reputation. Unhappy workers and dissatisfied customers can have a negative long-term effect on productivity and sales.
If you’re thinking of an M&A as a way to scale and grow, discover more from our useful M&A FAQ article which addresses the most commonly asked questions we hear about the process.
If you’d like to know more about how to execute a successful M&A or value a target for acquisition, contact our team of expert corporate lawyers. Get in touch on 0800 689 1700 , email us at enquiries@harperjames.co.uk, or fill out the short form below with your enquiry.
