While mergers and acquisitions (M&A) can be hugely beneficial as a way to grow and scale your company, they can also have downsides, not least the potential for overvaluing the target, leaving you out of pocket.
In this guide we will take a look at the M&A landscape and walk you through the upsides and downsides. We will also discuss a few high-profile examples that have seen the purchaser walk away with a loss having paid too much for the company being acquired, or not having been able to exploit the benefits in the way they’d wished.
If you’re thinking of an M&A as a way to scale and grow, read about this subject in-depth in our handy M&A FAQs. You can also find out how to value a company for acquisition in our article How to evaluate a company for acquisition.
- Mergers and acquisitions in a nutshell
- What are the benefits of engaging in an M&A?
- What are the downsides of an M&A?
Mergers and acquisitions in a nutshell
When two companies join together to form a single legal entity, this is known as a merger and acquisition.
This term has become a bit of a catch-all since individual companies can combine in a variety of ways. However, technically speaking, a merger involves a kind of joint venture where both entities agree to combine, whereas an acquisition usually involves a take-over of some kind.
Acquisitions can sometimes be hostile, where the company being acquired doesn’t necessarily wish to sell but the buyers manage to purchase a controlling interest.
There are many different types of M&A:
- Horizontal – This is where companies in the same sector join forces. For example, two soft drink manufacturers.
- Vertical – Companies that operate at different levels in the supply chain merge. For example, a food manufacturer buys a packaging company.
- Conglomerate – The merger of two industry heavyweights in different industries. For example, Amazon and Whole Foods.
- Concentric – Companies operating in the same sector but at different supply chain levels. For example, a manufacturer of gaming hardware buys a game developer
What are the benefits of engaging in an M&A?
Here are some of the ways an effective M&A can benefit the purchaser, the seller, or both:
If you structure your M&A carefully, you can bring added value to the deal and help it work well for both sides by maximising the tax benefits. It’s important to make sure your deal documents, like term sheets, spell out these tax consequences so that they’re clearly understood from the outset.
Tax benefits may be different depending on whether you’re considering a purchase of the shares or the assets of the target company.
Here are some of the ways structuring your deal for tax considerations can help add value:
- Where a company is acquired by a purchaser of shares, any tax losses may be available to set off against future profits of the buyer
- Where this is an asset rather than a sale, you may be able to claim capital allowances for money you spend on plant and machinery and get tax relief for money spent on intangible assets like IPR
Economies of scale and synergies
Where two firms merge, they can often make economies of scale. For example, a larger firm may get a bigger discount when buying raw materials, obtain a more competitive rate of interest, or gain access to more cost-effective machinery driving down the marginal costs of producing each item it makes. Alternatively, companies can combine premises in the same location, saving on lease and employment costs.
In addition, synergies can drive out benefits in M&As, such as reducing duplications in management teams and skillsets that result in more efficient operations and reduced costs, as two jobs are combined into one. Or, the acquiring firm gets access to a new sector or new set of customers, increasing its profits and ability to diversify, plus enabling it to scale and grow.
You can read more about different types of synergies in our article FAQs: dealing with mergers and acquisitions.
Access to talent
Some skillsets are in short supply, and labour shortages have become more common after Brexit. An effective M&A can provide a purchaser with access to specialised workers that they might not have otherwise been able to attract, for example, an experienced sales team. It may also save on training and development as it gains access to workers that are already skilled.
Where two companies merge horizontally, this can be a cost-efficient way to scale and grow, particularly where they’re operating in similar sectors. By combining smaller competitors in a single market, a single operator can soon come to dominate their sector by acquisition rather than organic growth.
So much for the upsides, what are the downsides of an M&A?
What are the downsides of an M&A?
Not so fast. One downside of growing your business through acquiring your competitors is the impact of competition rules. These are designed to restrict or prohibit mergers that would lead someone to dominate a market or sector. This is because market domination can lead to behaviour that constitutes an abuse of that dominant position. For example:
- A company might impose unfair terms on its suppliers or buyers, such as exclusivity
- It may raise prices too much, or drive them down to force out competitors (think Amazon charging less than cost price for nappies, forcing out a competitor nappy business)
- Denying access to essential facilities
- Tying, or in other words forcing someone who buys one product also buy a different product
Generally, to be considered ‘dominant’ in a sector, you’d have to have 50% or more of a market share, but depending on the context, this can go as low as 40%. If your business is guilty of abusing your market position, this can lead to fines and restrictions on your business.
Culture differences and clashes
One of the key attributes of successful businesses is good company culture. An effective culture can drive better morale leading to increased productivity. However, when two companies join, the culture is likely to be affected, often negatively, as the two ways of doing business clash. This can be a drag on productivity.
In addition, differences in pay and conditions of work may need to be harmonised, or this might not be possible, causing employee grievances and staff turnover.
Integration problems and operating delays
The flip side of economies of scale is diseconomies of scale. While one of the main aims of mergers can be to reduce costs and grow, this doesn’t always work out in practice. Larger firms can be more inefficient than smaller ones – that’s why companies tend to envy the agility and responsiveness of start-ups and often try to emulate them by streamlining decision making.
Integration problems can arise like this:
- Trying to combine two different supply chains or financial systems causes errors and duplications
- Management teams may not be aligned in the objectives and methods of working
- Administrative costs can grow as the combined company is more complex to run
- Different production lines or software incompatibilities can prove costly to sort out
As well as causing logistical problems and unexpected costs, integration can lead to delays and operational inefficiencies as managers struggle to combine operations. This can cause a drag on productivity impacting customer satisfaction and leading to a loss of business.
Potential overpayment by the buyer (plus some examples of where this has happened)
It can be tricky to value a company for acquisition, so we’ve written a M&A evaluation guide that looks at some of the issues involved. Very often, companies who are lagging in certain sectors or with types of users try to solve the problem by buying a competitor. This is the reason that Facebook acquired Instagram – Facebook felt that it wasn’t acquiring enough mobile users, so acquired the fledgling Instagram enabling it to capture this market more quickly.
M&A isn’t a magic bullet, however, and one potential problem is overpaying for the target. There are three potential reasons for this:
- Firstly, buyers fail to value the business correctly, overestimating its intrinsic value
- Secondly, buyers don’t follow valuation best practices
- Thirdly, buyers underestimate how difficult it is to successfully integrate a company
For example, in 2001 Hewlett Packard bought the European data company Autonomy for $11.1B. It turned out that Autonomy had been woefully overvalued and the M&A ultimately failed. The purchase was eventually written down and Autonomy’s assets were sold.
Nokia was a runaway success in the early days of mobile phones, producing user-friendly designs that customers loved. In contrast, Microsoft was lagging in its development of mobile-led products and saw its acquisition of Nokia as an easy way to move seamlessly into this market. However, its joint project the Lumia phone failed to be the moneymaking venture that Microsoft had hoped and it lost $7.6bn from the deal.
Failure may jeopardise future success
A failed M&A can often tank or slow the progress of an otherwise successful business. To guarantee success, you should make sure that you bake into the deal a sufficient margin of time and costs, post-transaction, to get the fit right and move the new business forward. Spend too much time or too little effort on integration, and you may feel the impact for a long period to come.
It’s important for business owners to remain hands-on during the post-implementation phase, and not delegate too much of the spadework to managers. Retaining a high leadership profile is one way to avoid the culture clashes that can set in once teams merge.
Another reason that failed M&As can damage company is reputational. Unhappy workers and dissatisfied customers can have a negative long-term effect on productivity and sales.