Acquiring a Company in Corporate Mergers & Acquisitions

In contrast with purchasing a small, privately owned business where most buyers are individuals looking to own their own business, corporate mergers and acquisitions are often a strategic move of corporations to increase their competitive advantage.

There are 6 principles that assist corporate executives in acquiring companies. Click next to explore the right reasons for acquiring other companies.

1: Reasons for Acquisitions
2: Should you Outsource Instead?
3: Relative Costs vs. Control
4: Levels of Diversification
5: Common Reasons for Failure
6: Effective Acquisition Strategies

Reasons for Acquisitions

Corporate mergers and acquisitions can increase the firm’s competitive advantage, or end up as a fiasco. To acquire a company is an expensive proposition, and one must utilize this strategy for the right reasons.

There are 5 common reasons a firm should consider acquisitions part of its strategy:

  1. To increase market power. There is an advantage to being big. The firm can negotiate better deals with suppliers and buyers, expand its distribution and service networks, achieve economies of scale or scope, and even form political coalitions.
  2. To overcome entry barrier. In competitive corporate environments, there are often entry barriers into a market such as economies of scale, brand equity & reputation, product & technology patents, and exclusive buyer or supplier contracts. When firms are looking to expand internationally, there may be cultural challenges and regulatory restrictions that would induce an acquisition of or a joint venture with a local company.
  3. To increase time to market of a new product. Internal development of new products and processes is risky, because 88% of product R&D projects fail, and 60% of the successful ones get imitated within 4 years. Acquisition provides an increased time to market with more predictable returns.
  4. To learn and develop new capabilities. It can often be expensive or impossible to learn the core competency of a competitor. If you can’t beat them, buy them.
  5. To increase diversification. The acquisition of related businesses can generate synergy among the companies, and the acquisition of counter-cyclical businesses can reduce the risks associated with economic, technological, regulatory, or competitive shocks. For instance, service and manufacturing companies are counter-cyclical, so a manufacturing company acquiring a service division would even out its cash flow.


Should You Outsource Instead?

Before acquiring a company, you should consider whether it makes more sense to outsource instead. There are 2 considerations that help firms determine whether it should perform the activity in house, or outsource it.
  1. Strategic value of activity. How important is this activity to your firm?
  2. Relative competence of your firm compared with the best supplier. How good is your firm at performing this activity compared with others?

If this activity is very important to your firm, and your firm is very good at it, you should perform this activity in house.

If this activity is not important to your firm, but your firm is very good at it, you can do it in house or outsource it.

If this activity is not important to your firm, and your firm is not good at it, you should outsource the activity.

If this activity is very important to your firm, but your firm not very good at it, you should consider partnering with another firm, and perhaps an acquisition.



Relative Costs vs. Control

When it comes to developing new products and capabilities, there are 8 possible strategies each with different costs and level of control. Acquisition is one of the 8 strategies, and it may or may not be the strategy of choice.

Take a look at the following:

Internal development

Highest cost

Most control

Acquisition

Minority investment

Joint venture

Franchising

Licensing

Management contract

Outsourcing

Lowest cost

Least control


These 8 strategies are listed in a specific order, with internal development providing the most control at the highest cost, and outsourcing providing the least control at the lowest cost. As you can see, acquisition provides a high level of control at a high cost. If this is not what your firm is looking for, one of the other 8 strategies should be considered.



Levels of Diversification

If acquisition is the strategy of choice, the next question is what type of companies one should acquire. There are firms that acquire related businesses, and firms that acquire completely unrelated businesses simply for diversification purposes. How diversified should your firm be?

There are 3 possible scenarios: First, remain in the dominant business and not diversify at all. Second, purchase a related business for medium level of diversification. Third, purchase unrelated businesses for high level of diversification. Research and our experience agree that scenario 2 is the best way to go. In other words, the firm’s performance is typically the highest when the firm purchases related businesses.

Why is this? The answer is that when a firm purchases a related business, synergy among the firms starts to occur. The firms can start to share resources, activities, knowledge, and core competencies. A firm may purchase its supplier (known as vertical integration), in which case both firms tend to do better as a result. Purchasing related businesses is a great way to achieve market power.

Purchasing unrelated businesses can work, although the resulting conglomerates (diversified firms with unrelated businesses) typically incur a diversification discount if the entire firm were sold at a later date, which means the sale price of the firm would be diminished somewhat. This is due to the fact that external financial markets are more efficient than the internal ones, and the diversification discount reflects the cost of coordinating unrelated businesses.

This is not to say that conglomerates are not a good idea. Purchasing unrelated businesses can be a great strategy if the firm is good at identifying and turning around inefficient or undervalued businesses, or is good at identifying and exploiting businesses in high growth markets that financial markets do not like to serve.



Common Reasons for Acquisition Failure

There are 4 common reasons that result in acquisition failure. Here they are:

  1. Integration difficulties. The corporate cultures at the two firms might be too different. There can be problems with developing and integrating financial and control systems. The status of the newly acquired firm’s executives can be a challenge, and the loss of key personnel could weaken the acquired firm’s capabilities and reduce its value.
  2. Inadequate evaluation of the target or future partner. The firm did not do its homework properly in the due diligence process. It may overlook the tax consequences of the transaction, the differences in culture between the firms, and the actions necessary to meld the two workforces.
  3. Large debt. If the firm incurs a large amount of debt in order to make the acquisition happen, the likelihood of bankruptcy is increased, the firm’s credit rating may be downgraded which increases the interest costs, and it may preclude investments in important activities such as R&D, human resource training, or marketing.
  4. Managers overly focused on execution. The managers may spend too much time and energy making the acquisition happen that they forget the firm’s main objectives.



Effective Acquisition Strategies

Over the years, we have found that firms achieve the most success when they follow these guidelines in making acquisitions:

  1. Complementary assets and resources. Buy firms with assets that meet current needs to build competitiveness.
  2. Friendly acquisitions. As opposed to a hostile takeover, friendly acquisitions make the integration process go more smoothly.
  3. Careful selection process. Deliberate evaluation and negotiations are more likely to lead to easy integration and building synergies.
  4. Maintain financial slack. Provide enough additional financial resources so that profitable projects would not be foregone.
  5. Date before marring. Use lower cost/risk arrangements to test compatibility before larger investments.

Should your firm consider acquiring a company, Advantage Commercial Brokers offer the experience, guidance, and negotiations to make your acquisition a success. We invite you to meet with our acquisition specialist to discuss your options. Click next to schedule a complimentary, confidential appointment with an acquisition specialist.

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