Mergers and acquisitions
Mergers and acquisitions (M&A) is the term used to describe the process of buying, selling and dividing different companies.
Merger or acquisition?
Despite the distinction between the two terms becoming increasingly unclear, mergers and acquisitions do differ somewhat:
A merger is the integration of two or more companies, in which all owners assume equal control of the combined businesses. Generally, mergers tend to be friendly with the decision to join companies being mutually agreed upon between firms and no single predecessor attempting to dominate the board.
There are three key types of merger:
1. Horizontal - This is generally where two companies with similar products and services join forces. This is a good option for a company wishing to increase their market share because it often means two competing companies come together.
2. Vertical - Mergers formed between two different companies producing different goods or services with a view to creating and distributing one finished product is know as a 'vertical merger'. For example, a manufacturer joining forces with a distributor or a supplier.
3. Conglomerate - This is where two companies in entirely different industries merge, for example a technology company merging with a catering company. This specific type of merger is usually used as a way of gaining access to a much wider market and customer base, or for expanding products and services.
An acquisition is when one business purchases a second and generally smaller business (often referred to as the 'target' company), which may then be absorbed into the parent business or run as a subsidiary.
If the decision is mutual between the companies involved, the target company will express an agreement to be acquired.
On the other hand, a business acquisition can be a hostile undertaking. In cases where the target company has not conveyed a desire to be acquired, a company will usually purchase large stakes of the target company with a view to assuming control once they hold the majority stake.
Advantages and disadvantages:
Mergers and acquisitions are both popular expansion methods because in many cases it is more advantageous to take on another firms existing operations or to join forces with another business, than it is to expand internally.
Of course, there are many additional benefits to expanding your business through the use of either of the above methods:
- Gaining experienced staff, additional skills and business intelligence
Acquiring a company that have a superior management structure and process in position will be of benefit to any buyer trying to improve their own systems. Taking on a company that has practices which complement your own and that can lend themselves well to a larger business is extremely beneficial to growth.
- Access to additional funds and assets
For a company wishing to expand, building brand new production or distribution facilities can be an expensive undertaking. Instead, acquiring a company can be a less costly way of obtaining assets for new development.
- Increased performance
If the business you currently own is underperforming, perhaps because you are struggling to expand regionally - buying an existing business could be a better solution than an attempt at internal expansion.
- Customer base expansion
Joining forces with another company will mean that you gain access to their customer base and therefore increase your chances of expanding your market share.
- Broaden products, services and prospects
The addition of new products and services that you are able to sell through your own distribution channels could help to improve customer satisfaction and market presence.
- Cost efficiency
Economies of scale - the larger a company and the higher their purchasing power the lower the unit cost tends to be.
In addition, if production begins on a much larger scale then output production will also increase and the cost of production per unit may come down.
- Gap filling
If one company has a major weakness that happens to be a significant strength in the other, combining the two will increase the chances of long-term survival and success.
Acquiring or joining forces with a company that you once considered to be a competitor means that not only do you now face less competition in your sector, but also that you have acquired new property, services and products for less than it would have cost to develop them from scratch.
For companies in the same sector and geographical location, combining resources through a merger or acquisition can make perfect business sense in terms of growth, cost reduction, profit, shareholder value and competitive advantage. However, nothing in business comes without its potential pitfalls and there is also a great deal that could go wrong with a merger or acquisition.
If you are considering a merger or acquisition then it is advisable to give both the risks and benefits equal consideration. Preparing yourself for any potential drawbacks could prove extremely useful should you choose to go ahead, so be sure to make yourself aware of the possible problems you may face:
- A bidding war
This point is especially pertinent in business acquisitions, in which more than one party could be determined to buy the same company.
If companies are unable to agree upon terms then a merger could become very expensive.
- Diseconomies of scale
If a business becomes too large, it may inflate unit costs.
- Incompatible business cultures
Clashes may occur between varying business types that may affect the successful integration of companies.
- Possible redundancies
Some workers may need to be made redundant, especially those at management level. This may influence the behavior of staff.
- Poor performance
The target company may not perform as well as anticipated.
The best course of action for any business thinking of going down the avenue of a merger or an acquisition is to consult a professional for expert advice. Management accountants and solicitors with experience in the sector and who have worked on similar deals will be able to provide advice about potential pitfalls that may emerge along the way.
Is my business ready?
If you are considering expansion through a merger or acquisition then there are certain steps you should take in order to establish the readiness and suitability of the business.
Before a company begins its search for a target business they should first carry out what is known as a SWOT analysis of their own company.
SWOT is an acronym for strengths, weaknesses, opportunities and threats, and is a good strategic planning method for understanding and decision-making. A thorough SWOT analysis can show a company how best to build on their strengths, resolve their weaknesses, exploit opportunities and steer clear of any threats.
Another useful technique is to carry out what is known as a gap analysis, which is essentially looking at where your business is now, where you want it to be in the future and then filling in the gaps. Analysing the bridge between the two ideals will allow you to think of potential ways to fill it.
It is important to assess your own business and its finances thoroughly and only if you feel absolutely confident that the deal will eventually produce a higher return than would be achieved from investing the same amount of money internally, should you proceed.
Before embarking upon either a merger or acquisition it is also essential, that company's have ensured they will be able to obtain the necessary finance.
Identifying target companies
There are various ways to research and find firms that may be suitable for a merger or acquisition. Before you approach the owners and begin negotiations, you should first draw up a profile of the kind of business it is that you really wish to acquire, or indeed merge with.
The idea of creating a company profile is to allow you to see whether the takeover or purchase will be beneficial and whether the target company is a good match with the acquiring company.
The target company should be assessed using a range of criteria - take into account relative size, business type, structure, organizational strengths, key competencies and marketing channels.
Once you have a clear picture of the type of target company you wish to acquire, it is then a case of investigating potential firms before valuing them. You can find more information about having a business valued over on our business valuation page, but to summarise a thorough valuation should involve scrutiny of the following areas:
- History - What is the firm's history?
- Performance - Current turnover and performance, profit and sales.
- Projections - Is there a business plan in place that details projections for the future?
- Reasons for sale - Why is the business being sold on? This may effect the valuation.
- Outstanding litigation - Are there any outstanding law suits against the business?
- Industry regulations - Have there been any recent changes to industry regulations that may impact the company?
Assessing the target business
Once a shortlist of potential businesses is in place, it is time to begin assessing them in more detail so that you are able to ascertain whether a merger or acquisition would a sensible and strong investment.
One of the most accurate ways of evaluating a company is to talk about it to individuals with whom it has regular dealings, for instance regular customers and/or suppliers. Doing so will provide you with the opportunity to enquire about their relationship with the business owner, their main contacts within the company, pricing structure in comparison to competitors and of course the products and services.
Providing you are not intending to embark on a hostile business acquisition, you could also approach the target business for information directly. You may wish to ask them for information about:
- customer base
- profit margins
- future forecasting
Business valuation is a procedure in which the buyer and their team of advisors conduct their own valuation of the target company to ensure that they will be paying a reasonable price for what is on offer.
A final valuation that both the buyer and seller agree is fair is often a difficult one to reach. Understandably, both parties will have an objective view as to how much the company is worth and you may find that it takes both time and negotiates to arrive at the final figure.
Though this is less common in mergers and acquisitions than it is in general business sale, sellers often place an unreasonably high price tag upon their business in a bid to compensate for any value that could be lost in negotiations. For this reason in combination with a variety of others, a secondary valuation from the perspective of the buyer is essential if you really want to understand the true monetary value of a business.
Placing a value upon a business with which you intend to merge with, or that you intend to acquire, works in a very different way to that of valuing a business that is being bought outright. For example, those considering a merger should make themselves aware of how much the other business is worth, and how that may have an impact upon the value of their own company.
If you are considering a merger or acquisition, the following valuation methods are recommended:
- Net asset value
The value of the company based on the net value of all company assets, minus any outstanding liabilities owed to creditors or the authorities etc. This valuation is also sometimes known as book value, and is often used as a starting point in valuations.
- Start-up cost versus acquisition cost
Any company considering an acquisition should compare the full cost of acquiring the company in question with the cost of starting up a similar firm. Be sure to include assets, product development, taking on employees and marketing the products and services in the estimate. This should give you a clear picture of whether the investment would make good business sense in terms of cost.
- Cashflow forecasting
This method allows you to predict future highs and lows in the company cashflow so that you can estimate how much available cash you are likely to have at any given time. Predicting the present net value is a good indicator of the worth of a company though it is a complicated procedure that is easy to get wrong unless you know how.
An industry expert or an accountant who is proficient in the field will be able to advise you on how to choose and apply certain factors so that you arrive at a realistic valuation.
- Price-Earnings Ratio (P/E Ratio)
A valuation based upon the company share price divided by its earnings per share.
If you wish to use P/E ratio to value a private company (a company that does not float shares on the stock market) then you will need to look up the P/E ratio for the relevant sector (this can be obtained from financial press such as the Financial Times). Once you have obtained this value, a discount should then be applied which takes into account the fact that the business is not on the stock market and therefore has less liquid value than a public company.
Similarly to cashflow forecasting, estimating the value of a company based on P/E ratio will be a difficult undertaking for an individual with no prior experience. Many accountants, lawyers and other specialist advisors have much experience in valuations and could help to reduce the chances of an individual paying over the odds for a company or owing unexpected debts.
For further information about business valuation, please visit our separate fact-sheet where you can find more in depth information about the varying valuation methods and processes.
Negotiating the deal
Once you have found a company in which you are interested it is time to set in motion the process of negotiations. Negotiating an M&A deal is not like haggling at a market stall - you need to have a merger or acquisitions strategy in place that is based upon a series of key questions:
- Will the target company oppose the proposition?
- What are the benefits of the merger or acquisition for the target company?
- What is the bidding strategy of the acquiring company?
- What are your first and final offers going to be?
As touched on previously - acquisitions can turn hostile if the target company doesn't wish to be acquired. In order to avoid unnecessary opposition and resentment it is always best to first try to reach an agreement before other methods (such as trying to obtain the majority stake in a company) are put into motion.
If there is a strong resistance from the target company over a potential acquisition then the acquiring company often put gentle pressure onto the target company, preferably without causing any alarm - this process is generally referred to as the 'toehold position'.
If the target company continues to put up a strong fight then the acquiring company may wish to bypass negotiations with the firm’s management and instead make a direct offer to the shareholders of the target company to purchase their shares for cash. A 'tender' offer - as they are known in the business world - is generally defined as such if it made up of the following attributes:
- The price offered is usually above that of that target company's current market value.
- The offer applies to the majority (if not all) outstanding shares.
- The offer is only open for a limited period of time.
- The offer is made to public shareholders.
Though this is not the same in all cases, a tender offer tends to cost more than a negotiated offer simply because of resistance from the management of the target firm. The fact that the target firm is now 'available' may also mean that other bidders may be attracted.
Due diligence checks are an essential part of any successful capital investment because they provide potential investors with the opportunity to thoroughly research the target company's background.
We all like to know as much as possible about what we are buying before we part with our money, and performing these checks means that buyers are given the chance to uncover any liabilities and verify any claims made by the target company before they part with any money.
Looking into a target company's value and risk will mean that unwanted surprises may be avoided in the future and this could increase your chances of a successful transaction.
The due diligence checks should generally be carried out by a team of financial advisors and should cover the following three key areas:
- Legal - Does the company have full ownership of all assets and are there any outstanding litigation issues? Ideally a lawyer should undertake this area of due diligence.
- Financial - Is all of the financial information that has been provided correct and up to date? An accountant will be able to verify this information for you.
- Commercial - What is the current position of the business on the market? Look into the businesses current market value and popularity as this may help potential buyers to gauge the probability of future success.
Do I need an accountant to help with due diligence?
It is perfectly acceptable for individuals to carry out their own due diligence checks independently, however, because of the complex nature of the procedure and the fact that there is so much to be done; experts recommend that the help of an accountant be sought.
An accountant will be well versed at performing these kinds of checks and will know what it is they are looking for. In addition, this also means that the buyer’s efforts can be focused on keeping their current business up and running.
If you would like to find out more about accounting practices and how accountants work, please visit our FAQ section for further information.
Driving the deal to completion
After both the target company and the acquiring company agree on a price and terms, there are certain legalities that need to be completed.
The seller, or target company, will need to provide a written statement to the acquiring company that will act as a warranty to provide the acquiring company with assurance about the impending deal.
If both parties have agreed that the seller is to reimburse the buyer in full for certain situations such as tax liabilities, they will also need to provide a statement of indemnity.
Cross-border mergers and acquisitions are an important strategy for any company wishing to expand abroad. Diversifying geographically means that M&As could help to satisfy future demand for goods, can work at reducing costs and may change the market share of the company and even the market structure.
If a company wishes to merge with a firm based outside of the European Economic Area, the Companies (Cross-Border Mergers) Regulations 2007 must be adhered to.
These regulations were introduced some years back in a bid to remove the legislative barriers that previously made it so difficult for UK companies to merge outside of Europe.
If the company resulting from the merger is a UK company they must ensure that they submit a copy of the following documents to Companies House. All of the documents detailed below must be returned to the registrar a minimum of two months before the first members meeting:
- Draft terms of the merger.
- If applicable, any court orders calling a meeting of members or creditors.
- A CB01 cross-border mergers form - available to download from the Companies House website.
A UK merging company must apply to the High Court or the Court of Session, for an order that certifies that the company has properly completed the merger. A copy of this document must then be delivered to Companies House within one week.
When they receive this document, Companies House will then send a notification of the order to the register of each company involved from another European Economic Area (EEA) and will also dissolve any UK company that is transferring to another EEA state. A note will also be placed in the register detailing the date on which the merger officially took effect and the assets and liabilities of the UK company were transferred across.
If the situation is reversed and the company resulting from the merger is in another EEA state, then a similar procedure is followed but this time Companies House will receive notice of an order from the registry or another EEA state approving the completion.
It is not advisable to embark upon mergers and acquisitions without the help of a highly qualified advisory team.
We can't all be experts at everything, so making use of experienced accountants, lawyers, solicitors, surveyors and other experts who will be able to provide valuable guidance in their specialist area, will help you to make the most well-informed business decisions.
A team of intermediaries to help you through complicated procedures such as business valuation, due diligence, finance, contracts, terms and legal aspects will mean that the correct procedures are followed, the sale is completed in the shortest possible time, and will ultimately mean that you are free to concentrate on continuing to run your current business.
When taking on a team of advisors you should ensure that you check the training and experience of any individual, you are thinking of taking on board. Enquire as to what previous experience they have in the field, what references they are able to provide, and what merger or acquisition strategy they have in mind to ensure the process runs as smoothly as possible.
Before taking any advisors onto the team, ensure that both parties have agreed upon terms and fees.
- Companies House - Cross Border Mergers - GPO7 guidelines
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