How to Assess Synergies in a Mergers and Acquisitions Transaction
The reason for doing any merger or acquisition should be simple. Don’t complicate the basic idea. You don’t need a complex idea to justify your M&A transaction. Keep it simple.
Many buyers try to over-complicate the strategy behind an M&A deal because they believe they have to be abnormally clever to be successful.
Yes, many businesses in your industry probably understand what the industry’s challenges are and what the evolving customer needs are. As such, everyone knows what the solution is or should be. But most businesses don’t have the time, courage, or ability to execute the idea.
What separates the successful business leaders from the unsuccessful business followers is execution. Not superior intelligence or knowledge. Most industry veterans are intelligent. The rare skill is execution of knowledge or ideas.
So, let’s take a look at the different potential synergies available in mergers and acquisitions transactions. These are some of the reasons why deals are done in the first place. One or more of these synergies may apply to your deal.
In our conversation below, let’s assume that you are the acquirer or buyer.
CULTURAL SYNERGIES
Business is people. Business is run by people. People have different personalities and professional styles. As any M&A investor or advisor will quickly tell you, the number 1 reason why an M&A deal fails is due to the cultural differences between the acquirer and acquiree.
The professional style of the business founder or top manager generally determines the culture of the business.
It’s difficult to place a numerical value on culture. Assessing culture is assessing how you feel about the other party as you go through the M&A process. You must observe their work style carefully and decide early on if it would fit well with your company’s style.
AOL Time Warner Merger
A culture clash was one of the major reasons for the highly-publicized failure of the $164-billion merger of AOL and Time Warner in 2000 during the Internet bubble.
AOL consisted of technology executives who were flying by the seat of their pants as they attempted to create a brand new online media industry. Everything was new. There were no rules to the game. Things were moving at lightning speed. They were making things up as they went along.
Time Warner consisted of traditional media executives who operated quietly in a very stodgy, old industry in which there was very little innovation. It was an established business. There was nothing new. It recruited professional managers from the top business schools to maintain its business.
These 2 sets of personalities and cultures clashed from Day 1 of the merger. There were a lot of other reasons why the merger failed. But from a culture perspective, the merger was doomed from the start.
The Newly-Rich Owner
When a business is acquired, somebody will become richer. The owner of the business that is acquired will receive a nice cheque or stock for his years of hard work. Always assume that if the previous owner sticks around after the sale is closed, he will never work as hard for the buyer as he did for himself.
Before an entrepreneur decides to sell his business, he begins to mentally check out of the business. This could be due to fatigue or boredom. He wants to rest or move on to other things. He may be physically present at the business after the sale but he is mentally absent regardless of any deal you have structured with him.
These conflicting interests of the buyer and seller create a new culture clash of its own. As a buyer, you must have a plan to address this problem as soon as possible.
Some deals include an earn-out for the seller. In this way, the seller receives partial financial compensation up-front and the rest upon hitting certain targets for the new owner. These could be revenue or profit targets. In other scenarios, the seller is offered a consulting contract with the buyer.
However, no matter which compensation structure is used, these are temporary arrangements. The buyer must plan for life after the previous owner.
The Overlooked & Under-Compensated Managers
Look beyond the balance sheet. Who is the number 2 at the company? Who are the people really running the day-to-day business operations for the previous owner? Which important managers did not get rich from the sale of the business?
These are the people you must zero in on. These are the undervalued assets that don’t show up on a balance sheet. You need to assess their value to the business and structure compensation plans to incentivize them to work hard for you.
These hard-working managers are almost always overlooked during a business sale. Never surprise the key managers by suddenly introducing to them a new boss that they have to answer to after the business is sold. Get these managers involved during the due diligence process. They run the business daily and will know best whether the business marriage will work or not.
You can uncover an undervalued and overlooked superstar manager for your new merged business among these people.
FINANCIAL SYNERGIES
In this section, we’ll quickly look at a few areas that could provide cost-savings or revenue growth to a new merged entity. Your accountant or M&A advisors can perform pro forma financial projections to identify financial synergies.
1. Vendor Contracts
Either the acquirer or acquiree may have cheaper vendor contracts than the other party. As such, the new merged entity could use its relationships to buy cheaper products or services from its suppliers.
2. Distribution & Marketing Contracts
Can the new bigger and stronger entity get better distribution or marketing deals?
For example, a newly-merged software company that has a larger customer base may be able to get better distribution deals with its re-sellers. An Internet company that has larger website traffic and more registered users can charge higher advertising rates to advertisers.
3. Lower Taxes
If the acquirer and acquiree are located in different tax jurisdictions, the deal can be structured such that the surviving entity is headquartered in a jurisdiction with lower taxes.
4. Asset Sale
In an asset sale, the acquired assets can be stepped up and the buyer can borrow money against the higher asset value to finance the acquisition. Then, with the lower costs, the higher cash-flow can service the debt payments.
5. Net Operating Losses
The buyer can use accumulated net operating losses and tax credit carry-forwards from the seller to offset profits in the buyer’s business and reduce tax leakage.
6. Cheaper Financing
A large corporation will almost always get cheaper financing terms for its business operations than a smaller corporation. In fact, if a business is very small and regional, it is often cut out of most traditional financing options.
As such, a larger merged entity with more diverse products, customers, and geographical regions served can obtain better financing terms. After the business purchase is closed, and you have a new stronger balance sheet, it may be time to re-visit the local bank to negotiate new or better financing terms.
OPERATIONAL SYNERGIES
Operational synergies should always be assessed with skepticism. In some cases, it literally requires studying line items on financial statements to identify potential cost-savings.
But what you view as a potential cost-saving on a financial statement may not translate exactly as such in the actual business operations.
Let’s use a popular cost-cutting measure to assess operational synergies: payroll cuts.
Payroll Cuts
The most popular line item that most buyers look at to cut costs is payroll. Payroll is usually a significant expense in most businesses. As such, redundancy or staff cuts are seen as a simple way to quickly slash expenses after acquiring a business.
But before you start firing people, let’s look at a common scenario in small- to mid-sized businesses.
Let’s say the acquirer’s business has 12 employees and the acquired business has 6 employees. As a buyer who has never run the seller’s business before, can you prove without a doubt that the new entity can operate with less than 18 employees?
On the surface, it may seem like a no-brainer to get rid of that extra Operations Manager in the merged entity. However, most employees in small- to mid-sized businesses perform tasks outside of their official job titles and descriptions.
So, getting rid of that “redundant” job title may leave you with a hole in your operations. If you fire that operations manager, you may need to replace him with an expensive specialist to handle the unofficial tasks that the manager used to perform.
REVENUE SYNERGIES
Revenue synergies are usually easier to measure. For example, the additional customers, subscribers, users, and revenues that are acquired in a business sale are generally easy to compute prior to closing the sale.
But you must still perform proper due diligence and double-check these numbers.
How are revenues accounted for? Are customers, subscribers, or users active? Can you really get more revenues out of additional subscribers such as additional advertising or subscription revenues?
CORPORATE SYNERGIES
Maybe the new merged entity only needs one corporate law firm or accounting firm for its legal and accounting needs. The company can get rid of the extra set of lawyers and accountants.
Generally, corporate expenses are not a large expense and they’re not material enough to drive an M&A deal. But savings are good wherever they can be obtained.
INTANGIBLE SYNERGIES
Generally, it is very difficult to value intangible synergies such as increased brand value created by a business sale. My advice is always be skeptical of any non-measurable intangible synergies.
Author: Kris Tabetando
Kris Tabetando provides mergers & acquisitions (M&A) advisory and brokerage services to Internet companies. He also partners with investors to acquire & manage Internet businesses.
- Connect with Kris:
