If you want to take your small business to the next level you should not ignore mergers and acquisitions as an important opportunity for growth.
M&A is not just for large firms. Small firms should not underestimate the importance of mergers and acquisitions as a real path to achieve rapid growth.
Mergers and Acquisitions – A Path To Accelerate Growth
We mostly hear about M&A activity among large well-known companies because those deals are all over the business news. In reality, however, M&A transactions occur more regularly between small to medium-size firms than between large companies.
Smaller firms should not ignore M&A. If you’re serious about growing your firm it should be an important topic on your strategic planning agenda.
What Is a Merger?
A merger is when two firms roughly equal in terms of size, customers, and scale of operations, decide to join operations. The two companies combine and create a new firm under a new name.
Owners and employees of both businesses usually stay on board, either in the same or new roles. The new company issues new shares to the investors/owners.
If you merge with another company, you retain ownership. Just with a new legal structure and company name.
What Is an Acquisition?
In an acquisition, one company purchases the majority or all of another company’s shares to gain control of that company. Usually, the acquired firm is smaller than the firm buying it.
An acquisition does not result in the creation of a new company. The acquirer simply absorbs the target firm into its operations.
If you are the business owner of the acquired company, you give up ownership. Cashing out could actually be part of the business owner’s exit strategy.
How Mergers and Acquisitions Create Growth
M&A can present an important path to a company’s growth. There are many reasons why a company might want to pursue an M&A strategy, such as:
As a result of the synergy from combining business activities, overall performance efficiency increases, and costs tend to drop. Each company builds on the other company’s strengths.
If a company has reached a limit to organic growth it’s often a smart idea to acquire another firm to expand more rapidly. The buying firm might look for a promising startup company to acquire and add the new revenue stream as a new way to profit.
If there are many competitors in a particular market, companies use M&A to reduce excess capacity, eliminate the competition, and focus on the most productive providers.
Many M&A deals are aimed at eliminating competition and increasing market share.
In a highly fragmented market, an M&A initiative reduces the number of firms in the market. This is attractive from a marketing and pricing power perspective. Also, the new, larger entity is better able to position itself as the market leader in the eyes of the customer.
On the downside, buying another firm typically requires paying some price premium. But this depends on the willingness of the target company to sell. A motivated seller, perhaps a business owner ready to retire, may just want to get out and not drive a hard bargain.
Entering New Markets
Expanding into a new market, perhaps another country, requires knowledge of that market and time. Rather than starting from a blank sheet of paper, buying an existing company already active in that market is often the quickest way to reach your goal.
This is because the acquired business already has the people, the brand, and other assets in place. This helps the acquiring company to quickly start off in the new market from a position of strength.
Gaining New Technology
In the same vein, it is often more cost-efficient to acquire a company that already has implemented a new technology successfully rather than spending the time and money to develop the new technology yourself.
Increasing Supply-Chain Efficiency
By buying out a supplier or distributor a business can eliminate an entire tier of costs.
Specifically, acquiring a supplier, known as vertical integration, lets a company save on the margins the supplier was previously adding to its costs. And, the company gains the ability to ship out products at a lower cost.
Different Types of Mergers and Acquisitions
There are various types of mergers and acquisitions, depending on the goal of the companies involved. The most common types are:
- Horizontal Integration – This occurs between companies operating in the same industry, typically between two or more competitors offering the same products or services. This is common in industries with a small number of firms. The goal is to create a larger business with a greater market share and economies of scale.
- Vertical Integration – This occurs when two companies operating at different levels within the same industry’s supply chain combine operations. The main goal of this kind of integration is to increase synergies through cost reduction.
- Conglomerate – In a conglomerate transaction, the two businesses come from different industries or locations, increasing their mission and scope. The businesses are not direct competitors. This is a classic diversification move.
- Market Extension – Market extension integration occurs between two businesses that sell similar products but compete in different markets. This creates access to a larger client base.
- Product Extension – In a product extension the products of both firms complement one another. Generally, the businesses are active in the same market, but they are not direct competitors.
Small Business Acquisitions Are Mostly Friendly
In a friendly acquisition the owners of the target firm agree to be acquired. This is often the main exit strategy for a small business owner. In this case the owner of the selling company may be actively looking for a buyer.
The acquiring company purchases the assets of the target company after reviewing the financials and other valuations for any obligations that may come with the assets.
Once the terms have been agreed upon and legal requirements are met, the acquisition can proceed.
Evaluating Acquisition Candidates
Before making buying another firm it is important to evaluate whether the target company is a good candidate.
- Is the price right? – When acquisitions fail, it’s often because the asking price for the target company is too high.
- Examine company debt – An unusually high debt load carried by the target firm should be a clear warning sign.
- Undue litigation. A viable target for acquisition should not be burdened with a high level of litigation.
- Sound financials. A good acquisition target will have clear, well-organized financial statements. This helps to complete the due diligence process. Complete and transparent financials also reduces the likelihood of unwanted surprises after the acquisition.
Because of the level of sophisticated analysis that’s required, many companies decide to work with M&A consultants to guide them through the process.
M&A To Create Competitive Advantage
Mergers and acquisitions are more successful if both companies apply the same focus, consistency, and professionalism to it as they do to other critical business decisions.
By taking this approach M&A becomes a strategic initiative aimed at achieving competitive advantage.
Develop a strategic approach to M&A
It is not uncommon for business strategy to provide only a general direction on why and where to consider M&A.
Often, companies use M&A indiscriminately to purchase growth or an asset, without a thorough understanding of how to create value.
As a result, companies waste time and resources on targets that are ultimately unsuccessful. They end up juggling a broad set of unfocused deals.
On the other hand, successful companies develop a pipeline of potential acquisition opportunities around two or three clearly stated M&A themes. These act as business plans that utilize both M&A and organic investments to meet a specific objective.
M&A initiatives need to have clear goals and fit the company’s strategy. The outcome of an M&A transaction should be clearly measurable in market share, customer segment, or product-development goals.
Know your reputation as an acquirer
If you’re the acquiring company, it is important to think about how your reputation stacks upon against the competition.
Some of the largest organizations are perceived as attractive buyers by small and nimble targets, largely due to how they present themselves and manage M&A. The best among them tend to lead with deep industry insight and a business case that is practical and focused on winning in a marketplace instead of on synergies or deal value. They let target-company managers see how they fit into a broader picture. They also have scalable functions and a predictable, transparent M&A process that targets can easily navigate.
Finally, they are purposeful about how they present themselves, supporting executives with consistent and compelling materials that demonstrate the best of the organization.
As a result, they are able to use their position in the market to succeed in dimensions that go beyond price—and are often approached by targets that aren’t even yet “for sale.” This is a real competitive advantage, as the best assets migrate to the companies they perceive will add value, decreasing search time, the complexity of integration, and the chances of a bidding war.
Maintain a clear strategic vision during the due diligence
It is not uncommon for the strategic goals to get ignored during the due diligence process. By focusing too much on the financial, legal, tax, and operational aspects, the strategic reasons for why the merger or acquisition should be considered may get lost.
It is important to stay focused on the strategic goals of the M&A initiative.
Re-evaluate synergy during the mergers and acquisitions process
Failing to update expectations about the potential for synergy as you learn more about the target company is one of the most common, but avoidable, pitfalls in any transaction.
Companies that treat M&A as a project typically build and get approval for a company’s valuation only once, during due diligence.
In a rush to complete the process, and for simplicity, they may take a rigid approach to integration. They fail to recognize the unique attributes and requirements of different deal types. Or, they may be unstructured, ignoring established deal processes relying instead on a key stakeholder to make up their mind. There is rarely an opportunity to revisit value-creation targets with executives, and other stakeholders.
This makes it hard to reassess synergies and targets throughout the life cycle of an M&A deal. Valuation targets are set early on and are virtually locked in by the time integration starts.
This forces the organization’s aspirations down to the lowest common denominator by freezing expectations at a time when information is uncertain and rarely correlated with the real potential of a deal.
The reason is simple: financial due diligence is conducted with intentionally imperfect information, as each side does its best to negotiate favorable terms in short time frames. It’s typically focused on likely value instead of potential value. This works for managing the risk of overpaying, but it’s not how you would actually manage a business to its full potential.
Industries With The Most M&A Activity
As you may expect, the level of M&A activity differs between industries. Mergers and acquisitions are most common in healthcare, technology, financial services, and retail.
In health care and technology, many smaller companies find it challenging to compete in the marketplace with the handful of big gorilla firms that control the industry. The smaller firms often find it more lucrative to be acquired by one of the giants.
The technology industry moves so rapidly that it takes a massive presence and huge financial backing to remain relevant. Instead of trying to compete unsuccessfully, a smaller company will often team up with one of the big players.
M&A Is Not a Silver Bullet
Keep in mind, mergers and acquisitions are not the best or only option for growth. Companies able to achieve a strategic goal using their own resources should take this route. This avoids the costs and risks of a merger or acquisition.
On the other hand, rapid growth can be achieved if you can manage the complexity of an M&A transaction by creating the capabilities needed to realize its full advantage. That said, working with an M&A consulting firm to guide you through the process is always a good idea.