Growing your Business Through Mergers and Acquisitions

April 11, 2022

Written by Robert L. Dean, CPA, CVA, Managing Partner of Heard, McElroy & Vestal, LLC

The business world is consolidating rapidly. Companies of all sizes are looking to increase their size, power, and efficiency through merger and acquisition (M&A) activity. It’s no surprise as they face fierce competitive pressures and increasing demands from investors for successful returns.  Through the second quarter of 2021, global M&A activity reached $2.4 trillion – surpassing last year’s record by 158%, according to a Refinitiv Deals Intelligence Report.

Well-designed and executed mergers and acquisitions, and the benefits they bring, are proven value creation levers.  Mergers and acquisitions can create synergies – a condition where the new business as a whole is greater than the sum of its parts. Two organizations combined can often increase their efficiency, reduce cost structure, improve competitiveness, open new sales channels for both entities, and combine complementary product and service offerings.

What’s the difference between a merger and an acquisition?

While mergers and acquisitions can bring similar benefits to the combined entities as a whole, they are separate and distinct processes. In an acquisition, one company takes over partial or complete ownership and control of the other company. The purchase typically goes one way: the acquiring owners pay compensation to the selling owners, buying more than 50% of voting shares. The sellers can stay on as employees of the new firm or walk away, retire, join other companies, or start new enterprises.

In a merger, on the other hand, there’s an exchange of equity. Each group of owners, and/or the companies themselves, receive shares in the new combined entity. There’s often a new brand established, and if the company is publicly traded, a new stock exchange listing.

Mergers are voluntary; both parties must agree to the merger and cooperate to make the process work. Acquisitions are sometimes involuntary or hostile; a stronger company may buy enough shares in the open market to take control and take over the acquired company's assets, possibly intending to lay off much of the acquired company's workforce or senior management team.

When is a merger vs. an acquisition appropriate?

A merger may be more appropriate when the smaller company's management team is capable and energetic, and where both sides can see the strategic benefits of combining. Mergers may also be appropriate if the smaller or weaker of the two entities can bring a lot to the table in terms of leadership, talent, personal and social capital, technology, or market connections. Having a good match between the two organizational cultures can be important, as well.

An acquisition may be more appropriate if the owners and senior management teams of the acquired company are looking to exit or don't want to be acquired. It may also be appropriate if the gaining company has a much stronger brand than the selling company, and re-branding doesn't make sense.

What are the strategic benefits of a merger or acquisition?

Where a merger or acquisition goes well, there can be many potential benefits:

Greater size

Larger companies tend to trade at a premium to smaller companies. Large companies have scarcity value – there are fewer of them – and with good management, they can usually operate more efficiently.

More customers, more quickly

Customer acquisition is expensive and takes time. It can cost a significant amount of money for marketing, advertising, and sales commissions to acquire a new customer, especially in more mature markets.  Sometimes, it’s much less expensive for a company to buy an established customer base with predictable long-term revenue than to incur the marketing costs to fight for it.

Increased purchasing power

Mergers increase purchasing power. Suppliers often provide better pricing for higher volume buyers, so combining two smaller corporations into one larger corporation can even lead to cost savings. Contracting and acquisitions teams can have each company’s new vendors bid competitively for the rights to sell to the new larger company – a process called vendor consolidation. The result is significantly increased efficiency and a cost structure advantage over smaller competitors who are unable to get this favorable pricing.

Improved benefits design

The same logic can also apply to employee benefits. Companies with a larger workforce can expect better pricing on health insurance, disability insurance, voluntary benefits, pension, and 401(k) administration, and other benefits.  Not only are there cost savings, but the combined company may be able to improve the overall benefits offered to employees.

Optimized or diversified geographical footprint

Companies can diversify their exposure to local and regional economic risks. For example, a restaurant franchise owner has capital and would like to expand to an up-and-coming, fast-growing suburb. The franchise company won’t allow the expansion because the territory is held by another franchisor who would also like to open another store – but doesn't have the capital. The potential for synergy is obvious: The owner with the capital can buy or merge with the owner with the desirable territory. This is territorial expansion through M&A.

Less competition

Acquiring a direct competitor not only provides the assets, intellectual property, talent, and goodwill of the selling company, it also eliminates a competitor.  Competition tends to drive up the cost of acquisition and slows customer growth.  An acquisition or merger may reduce the premium cost of going toe to toe with the competitor.

Fewer gaps in product and service line

Mergers and acquisitions often offer opportunities to upsell/cross-sell existing customer bases. For example, a manufacturer may acquire a transportation company with a fleet of vehicles and experienced drivers – and charge both for manufacturing and delivery. This offers two opportunities for profits, provides a competitive advantage over competing manufacturers, or accomplishes both.

Better talent and intellectual capital

Mergers and acquisitions can also bring much-needed talent and intellectual capital in-house.

Greater efficiency and less redundancy

Mergers and acquisitions offer opportunities to reduce costs by eliminating or consolidating redundant positions and departments, therefore, there’s no need for two different CEOs and CFOs. Expenses can be reduced at the top and apply to all departments and functions up and down the organization.

Reduced real estate and physical plant costs

When two organizations combine by merging or acquiring, they may be able to reduce real estate expenses, sell unneeded properties to raise cash or rent them out, or both.

Challenges to successful acquisitions and mergers

Both acquisitions and mergers usually require funding. Acquisitions frequently involve a large amount of leverage, which may be concerning to shareholders. Increased debt means increased risks in the event of a setback. If you fund it with equity, shareholders will be concerned about the dilutive effect of additional equity issuance. There are advantages and disadvantages to both.

Mergers and acquisitions also generate substantial costs of their own. Expect to pay significant sums to outside investment bankers, business brokers, legal, and accounting.

There are also internal costs to consider: Severance packages to people being let go, bonus packages to encourage people to stay on through the transition, and training people and departments on new technologies, such as accounting and HR software.

Cultural fit is also a major consideration.

In many cases, an acquiring company can let the selling company continue to operate, even under its former owner, relatively autonomously. 

Approaches to finding merger and acquisition targets

Make a list of direct competitors in your market and in adjacent markets – either geographically or conceptually. 

You can also look to acquire companies that operate up or down the production and distribution chain, bringing more capabilities in-house, and building out a vertical monopoly. 

You can work with an investment bank or business broker. 

Leverage your own personal contacts. You may be able to find a great candidate for an acquisition or merger through your own network – and save on broker fees and investment bank commission costs, which are substantial.

Navigating the merger and acquisition process

If you’re ready to merge or acquire (or be acquired), there are multiple ways to start the process.

Consult with our office to prepare for the due diligence process. This is especially important for sellers. A company that is well-prepared for the diligence process will build confidence and command a higher sales multiple. Our subsidiary, Business Valuation Consultants, LLC, can assist in evaluating the sale or purchase price along with deal terms.

Engage a business broker or investment bank, especially ones who specialize in your industry. 

Be prepared to manage the human side of mergers and acquisitions. Even in the best of situations, conflict can arise in and between departments and managers. It can be a very stressful process for employees uncertain of their future and potentially damaging for the organization.

Navigating a successful merger takes sensitivity, compassion, foresight, work, and expertise.  If you are considering growth through a merger or acquisition, or if you’re looking to be acquired, contact our office.  We’d be happy to discuss your unique situation and how we may be of service.