Merger and acquisition (M&A) deals have consistently created more substantial lasting value for companies through economies of scale than organic growth alone.1 Still, many shy away from acquisitions due to potential complexity, lack of clarity on acquisition goals, and an absence of in-house M&A experience.
M&A activity is often approached as another job that needs to be completed as soon as possible, without considering how the deal will fit into the overall company strategy.
However, when an acquisition is approached from a strategic perspective and focuses on how it will drive competitive advantage, the deal becomes less of a transactional “job” activity and more of an integrated strategic opportunity.
This first installment of a three-part series on M&A will focus on the reasons for M&A, the design of a target operating model, ways to address people issues, and the risks of M&A.
Reasons for M&A Activity
Drive Company Value
While the end goal is typically to increase shareholder value, the company value created by this synergy of the two companies is greater than the sum of the two pre-merger companies. Synergy can be divided into cost and revenue.
Cost Synergy
A cost synergy will most likely result in a reduction in operating costs due to economies of scale. This is primarily because of shared services or fixed costs associated with the successful combination of the merged businesses, the reduction of duplicative services, and the distribution of those costs over a larger volume of business. These fixed costs are usually back office operations, IT systems, general management, and facilities.
Revenue Synergy
Revenue synergy is driven from a complementary revenue source like a new market, geographic expansion, or a product/service that offers diversification.
Diversify Customers & Markets
Customer diversification usually means expanding into new service lines to access new customers. In contrast, market diversification offers services in new areas for one of the companies involved in the merger. Additionally, the companies may devise a merger deal to lower the overall risk of one company’s operations. Both market expansion and additional services acquired through the merger allow for diversification of the company risk.
Increase Financial Capabilities
Every company has limited capabilities to finance operations concerning debt or selling equity. Many companies seek to acquire or merge with another company to create a consolidated entity to achieve a higher financial capability and deploy funds to grow the business further.
Reduce Competition
Sometimes a company may acquire or merge with a competitor to consolidate two businesses and achieve a single market share. However, this typically requires payment of a premium price, unless the target company is having financial or operational difficulties.
Tax Liability
One M&A strategy utilized by highly profitable companies is acquiring or merging with a company with a significant tax loss carryover. The merged companies will have a tax liability lower than the original company. Certain limitations apply to the timeframe and amount that can be carried forward in the combined entity, and special IRS restrictions apply to operational losses incurred as a result of an acquisition.
The rules are complex, and the unique transaction facts and circumstances determine the ability to take advantage of the losses in the combined entity.
Design the Target Operating Model
Define Organizational Chart & Roles
The target operating model should be designed based on the business role needs rather than the placement of specific individuals. To accomplish this, focus on the company’s vision and specific goals. This means defining the company organization chart and hierarchy, the individual responsibilities for each role, the scope of authority, decision escalation issues and levels, and profit responsibility goals for each area. This will align the hierarchy of the management roles with the organizational goals; only then should individuals be assigned to those roles. The underlying question that should be constantly asked is, “What are the cross-functional roles that drive value from the deal for the combined entity?”
At that point, an assessment should be performed to identify current personnel available and the skillset gap to fill those roles in the target operating model. The decision to either develop in-house training programs or contract with outside firms to close the skillset gaps is no small task but should be weighed against the risk of hiring a new employee for a management role.