If you’ve landed here, there’s a good chance you’re either a small business owner considering a merger, or you’ve been approached to merge with another company. Mergers can be a great way to scale and grow a business, potentially adding value for all stakeholders.
If you get things right from the start, you can bring two organisations’ operations together smoothly, streamline your processes, and combine teams behind a common goal. However, according to this report by consultancy group McKinsey, many mergers take longer than expected, or even fail, often because of a failure to involve employees fully. According to McKinsey, one of the golden rules of mergers is to make sure you consult fully with employees, involving them in the new organisational design from the start and winning hearts and minds. They have also concluded that taking decisive action and aligning teams behind the change works better than a staged process.
In this article, we take a look at how you can achieve the maximum benefit from a merger, explore common pitfalls and the steps you need to take to deliver your merger goals.
- Before you merge
- During the business merger process
- Post-merger integration
Before you merge
Mergers are quite different beasts from acquisitions, as we explore in our guide on types of mergers and acquisitions. An acquisition involves the takeover of one company by another in order to achieve a benefit for the acquiring party in terms of their existing business. A merger involves the combining of two equal partners for the benefit of each, although very often one of the partners has slightly more edge in terms of bargaining power.
Here’s our checklist of things to think about if merger is on your mind:
Do your homework
Once the merger process is underway, you and your advisors will be carrying out due diligence – an investigation into the business and legal affairs of both companies.
However, there’s a lot of research you can do ahead of time to make sure that you have evaluated the likely pitfalls and truly understand the nature of the business you are interested in. Aside from public information available for research, take the opportunity to talk to current and former employees and managers – they can tell you a lot about how the company functions, and its strengths and weaknesses. Depending on what you are hoping to achieve from the deal, you can focus your enquiries on the specialists in each organisation (finance, IP, sales or customer service for example) in order to get an informed view on fruitful areas to explore during due diligence.
What’s the outcome you’re hoping to achieve?
If you don’t have a very clear idea why you’re considering a merger and a vision for what you want to achieve, then you’re going to find it difficult to communicate this goal to your stakeholders and achieve a successful merger.
Consider this: 28% of companies interviewed by McKinsey said that a merger hurt morale in the long-term. To merge successfully, consulting your stakeholders (employees, shareholders, leadership teams) and getting them on board is vital from the start.
Define your objectives
Aside from your overarching goal, there’ll be certain specific reasons why you want to merge, whether that’s acquiring new customers, growing your share of the market, or gaining access to certain know-how or processes of another company, for example. You need to express these goals clearly and bring them to the forefront of your communications strategy from the beginning.
By defining your objectives, it not only becomes easier to make decisions as the merger progresses, but also helps avoid protracted negotiations on irrelevant or relatively unimportant matters.
Engage a professional team
You’ll need the support of a professional team of expert M&A lawyers behind you from the very beginning if you’re considering a merger.
Here’s the kind of help we recommend:
- A law firm experienced in successful mergers. On the team, you’ll need employment lawyers, corporate lawyers, intellectual property rights, and taxation specialists. Possibly a commercial lawyer too, in order to ensure that supplier and customer contracts transition smoothly to the merged entity.
- Corporate accountants who can look at the financial health of both companies to make sure you have the bandwidth to complete the deal. They can also help you obtain funding for the transaction if you need it.
- A communications guru. You may have one on the team already, alternatively engaging a professional advisor who’s used to dealing with mergers can really help bring the various parties together as well as communicating with third parties.
Consider the effect the merger will have on the companies’ owners
A merger will inevitably cause the shareholdings of existing shareholders to be diluted. A 10% shareholder of a merged company will likely hold 5% after the merger, and your owners will have to be prepared for the effect of this dilution, including a potential loss of voting power. If there are existing shareholders agreements, these will need to be renegotiated and a new agreement put in place covering the relationship between the shareholders of the combined company (newco).
The value of the shares in both companies involved in a merger are likely to be affected by a merger. Shares can go up or down over the short-term, and it’s wise to prepare your shareholders for this eventuality. Of course, in the medium- and longer-term, the expectation will be that the share price of the combined entity will rise due to the efficiencies and business effect created by the merger.
Think carefully about the costs involved
Mergers can be cost saving over time, but they can be expensive too, not only in terms of the direct overheads like advisor’s fees, but also in respect to the cost of change and the disruption that can cause. Staff turnover can become an issue, and productivity can dip as your team needs to deal with the demands of the merger as well as their day jobs. Trying to evaluate these costs and putting a price on the likely overhead of the deal will really help you get an idea of whether the merger is worth doing.
Consider multiple scenarios
A common mistake when planning a merger is to focus on the organisational structure – the eventual board of directors and chain of command rather than the nuts-and-bolts of the businesses themselves – how they operate and the company culture.
Understanding the companies’ processes and people (their skills and talents), as well as being precise about the benefits you hope to achieve, ahead of the merger itself, will enable you to plan for various different scenarios and adapt your stance if needed.
As you progress through the transaction and carry out due diligence, you can test out these different scenarios once you get a handle on the detail. You can then figure out how the new company might work most efficiently to take advantage of the potential benefits.
During the business merger process
Once you move into the transaction stage, here are the things you need to think about:
Stages involved in a typical merger
These are the most usual steps in a company merger:
- Initial research and planning including pre-contract discussions between both parties and possible agreement of an outline term sheet.
- Obtain in-principle agreement on finance and funding.
- Appoint your legal and financial advisors and brief your communications team.
- Initial communications to stakeholders about the merger.
- Due diligence and valuation of the businesses.
- Formulate a plan for merging the two businesses’ operations.
- Finalise the term sheet (or memorandum of understanding).
- Draft and negotiate the legal agreements.
- Finalise the legal agreements and complete the deal.
- Communications to stakeholders and the public.
Due diligence is the investigation of the business affairs of a company. Due diligence is essential to understand how a company works in practice and can be carried out in a physical space (known as a data room), or, more commonly, virtually.
These are the areas commonly covered during due diligence:
- How many employees does the business have, how are they remunerated and what are their skills? What are the pension arrangements?
- Are there any potential legal issues like employment claims or litigation pending or threatened?
- Are there any regulatory or licensing issues?
- Are there any financial issues like unforeseen debts and liabilities?
- How healthy are the company’s sales and cash-flow statements?
- What customer data is available? How is customer retention?
- Who owns property like real estate and IPR?
- What IT platforms does the company use and what processes and systems are in place?
- How robust are the company’s contracts with customers and suppliers? Might they be impacted by a merger?
- What is the company culture like, and how amenable are staff to a merger?
Planning and communications
According to research, a high proportion of mergers don’t go according to plan. So, while it’s great to put some milestones in place (and communicate these to stakeholders), it’s equally important to remain flexible as you move forward with your merger.
Having at least a skeleton plan for the deal will help motivate your team to keep moving forwards, when at times the work associated with the transaction can be burdensome.
When planning your merger and setting up your communications strategy, make sure that staff are consulted and not just broadcast to. They will likely have worries and concerns that it will be in your interest to address, such as pay and holidays. You can use an interactive platform to host your plan and timetable, and address questions and comments in real time.
As part of your comms strategy, you may want to consider the issue of branding, and what the new company’s brand will look like post-merger. This can also be a contentious issue. Consult your legal team to make sure your chosen brand names are available to be trademarked if necessary.
Deciding on a corporate structure
If two companies are merging, the most likely scenario will be that a newco will be created. Newco will acquire the shares of the two merging companies, and new shares issued to newco’s shareholders. If one of the merging entities isn’t a company, you may need to consider a different structure such as a purchase of assets. Your legal and tax advisors will help you decide the best structure for the transaction.
Your management teams will also be keen to know how the new board will be structured. These conversations can be difficult, and engaging a skilled employment law solicitor can help steer you through any tricky situations with executives
If, as part of your pre-deal investigations you’ve got a good handle on the company culture at your target, now is a good time to sit down with management and agree potential reporting lines. You’ll get a good idea at this stage how the teams will look and whether you envisage any potential clashes or other issues.
Finance and tax
Before you go into a merger transaction, you must fully understand your target’s financial position, and the tax ramifications of the deal. You’ll need an expert advisor on hand to help you with this, even if you feel fairly proficient in financial affairs. In addition, look carefully at revenue and cash-flow statements to get an idea of operating costs.
You’ll also need to conduct a valuation of the merging companies so that you can reach a share price for newco and allocate the shares fairly between the owners of each company. You’ll normally need the help of an expert valuer to assist with this.
Post-merger is the time when the rubber really hits the road. The ripple effect of a merger can last for months and years after the deal has competed. Your aim is to ensure that the performance of the new company is an improvement on the sum of the performance of the merging companies, and to achieve this, you need to meld their activities in as seamless a way as possible.
Here are our tips for achieving a successful merger of small businesses:
Communicate effectively with everyone involved
It’s normal that a merger will provoke anxiety in staff, and even shareholders. Employees may fear for their jobs, teams may be content working within their comfort zone and fear change, and managers may be anxious that their position and seniority will be threatened.
We recommend setting up an interactive platform so that staff can ask questions and hold regular Q&A sessions where managers can answer queries. If your company employs more than 50 staff, you may be legally obliged to conduct a collective consultation and have a formal system in place to this end.
Plan, plan, plan
If you’ve done your pre-merger spadework, you’ll already have a good idea of how to optimise the benefits of combining the two companies, and that includes planning how to meld together two different company cultures and ways of doing business.
Make sure you plan how to problem-solve the difficulties that are bound to arise within the leadership teams and how to reconcile the different approaches to operating the business. Figure out how to combine the various processes and systems to best effect.
Prioritise and problem-solve
Above all, take your time. Prioritise the changes that seem most important to implement and communicate clearly to the teams how these could happen. Use your teams to help you problem-solve and give them agency to test different approaches and find the best solution. During this critical period, make sure that your leadership team is on hand to supervise this process and stay close to the detail.
Don’t be afraid to change tack if things aren’t working out as you had envisaged and have a back-up plan in place if you feel that the merger just won’t work. If you’ve deal with this in your merger contract – your lawyer is essential here – then a divorce will be easy and painless.
Above all, make sure you have great legal and financial advisors on board at all stages of the process, both pre- and post-merger, so that whatever the outcome your most valuable business asset is protected.