Mergers and Acquisitions: Top Benefits and Risks You Should Know

Introduction

In 2021, M&A deals reached a figure of over $2.5 billion in the United States alone. Mergers and acquisitions have become so popular that many entrepreneurs’ business plan is to get acquired by a large corporation before moving on to something else.

Mergers and acquisitions represent a business transaction where two businesses consolidate into one. As is the case with every business decision, there are pros and cons to M&As, and you should weigh them carefully before you get into such a deal.

In this article, we’ll go over what mergers and acquisitions can bring to you, as well as some risks you should know about before you commit.

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Mergers and Acquisitions: 7 Benefits To Look For

If you want to increase your bottom-line profitability, expand your company, or find new revenue streams, M&A is a viable option to achieve that with relative ease. Of course, this depends on whether you have enough resources to do it without crippling your everyday business operations.

The main benefits of mergers and acquisitions are as follows:

1. Economies of scale and scope
2. More financial resources
3. Competitive edge
4. Access to new markets
5. Risk diversification
6. Larger talent pool
7. Tax liability minimization

Economies of Scale and Scope

In most cases, businesses consolidate with the aim of increasing their economies of scale. A larger company is often stronger, more productive, and more efficient by default than two smaller businesses competing in the same space.

With a merged or acquired company, you’ll receive the following:

• Increase the company’s assets
• Lower cost of production due to higher volume
• Increase your bargaining power with distributors

Another aspect is the economy of scope. As a company starts working on two related products, production costs and the cost of customer acquisition reduce. In other words, two products start working together to achieve the same goal.

M&As often allow businesses to increase their scope, which would be hard and time-consuming to do organically. For instance, Facebook had its chat app (Messenger), but it still decided to acquire WhatsApp to increase its scope virtually overnight.

More Financial Resources

When two companies merge, or one acquires the other, they pool their financial resources together, increasing the overall budget. This can result in improved production, a more sophisticated go-to-market strategy, and a larger marketing budget that can help you reach more customers.

Financial gains don’t always have to refer to money solely. Additional resources can include:

• Materials
• Suppliers
• Production facilities
• Know-how

Competitive Edge

With increased resources, you can gain a higher market share and influence customers more easily. Generally speaking, the larger the company, the harder it is to compete against it.

An acquisition of a successful company stops your rivals from doing the same and gaining a competitive edge over you.

It also gives you a financial structure to acquire businesses that are becoming popular in a certain niche. If you see a small company excelling in, say, fishnets, all you need is a takeover to reach their level of success.

Access to New Markets

Regardless of your brand recognition, it’s extremely challenging to enter a new market and build a following there. It takes time, effort, expensive marketing strategies, and creating production lines from scratch.

This holds true especially for global corporations that try to enter a foreign market, which contains established businesses and has consumers unwilling to change their habits. With an M&A, you take over a company that’s established in the market and reap the rewards of years of effort.

For example, Coca-cola could have started its own line of fresh juices and teas to compete in that market and build a new brand from scratch. Instead, they opted to acquire Fuze and profit from its already-established brand and consumer list.

Risk Diversification

Let’s say that, for whatever reason, people stopped using Google as their preferred search engine, and they all switched to Bing. That will be tough on Google, but it won’t kill them because they acquired YouTube, which made over $28 billion in 2021 alone.

With a new company under your wing, you can diversify your portfolio and mitigate risks by not focusing your company’s success on a single revenue stream.

Larger Talent Pool

One of the main issues for companies looking to dominate a market is the acquisition of the best talent. This is especially a factor in niche markets where expertise is necessary.

One way to overcome the problem is through M&A. You will not only have access to people already employed by the other business but also have a greater pull when it comes to hiring new top-level employees.

Tax Liability Minimization

If you intend to enter a new geographical market, acquiring a foreign company can bring you tax benefits. Many governments around the world offer tax reductions for M&As or impose lax taxation laws to begin with.

4 Merger and Acquisition Risks To Be Wary Of

If mergers and acquisitions brought only success, everyone would spend every cent they had on acquiring companies. M&As require large investments, adapting your production operations, and other often drastic changes that can crush your business if not done properly.

Some of the most common risks you will face are:

1. Doing poor due diligence
2. Overpaying for the target company
3. Overestimating synergies
4. Suffering from unexpected costs

Doing Poor Due Diligence

Before you commit to acquiring or merging, due diligence is crucial. Due diligence is a process during which the acquiring company gets access to crucial and sensitive information about the target company. This includes:

• Insurance
• Customer agreements
• Debt
• Compensation agreements
• Distribution agreements
• Contracts
• Financial stability

If you acquire a company without going thoroughly through these documents, you can end up with increased risks, poor valuation, and overall misdirected acquisition. It’s like buying a car—a nice color is not enough, you have to look under the hood.

Overpaying for the Target Company

One of the issues that arises from poor due diligence (among many other factors) is overpaying for the company.

Acquiring companies that overpay for the acquisition destroy existing shareholders’ value. To combat this, you need to create an extensive valuation report that includes all the facts that have an effect on a company’s price.

Overestimating Synergies

Synergies are often the main reason for an acquisition, with hopes to increase a company’s market share and competitiveness by boosting growth. The issue is, it’s hard to gauge and predict the effectiveness of synergies. 

Managers often overestimate synergies by up to 25%. Overestimation comes from:

• Unrealistic goals
• Incompatible company cultures
• Lengthy (or unsuccessful) integrations

Suffering From Unexpected Costs

Consolidating two businesses takes time and money—it’s not as easy as sending an invoice and signing a contract.

Due diligence (if done correctly) should go over the fees of advisors, legal teams, and investment banking services, but it can’t cover costs coming from unexpected issues, such as security threats.

Other potential costs you should consider include employee training, new salaries, severance pays, and rebranding efforts. Costs and issues can stack up quickly and overwhelm the acquiring company.

Mergers and Acquisitions: What’s the Difference?

Many people use these mergers and acquisitions as synonymous terms, and while they are similar, they do differ. Depending on which deal you do, you’ll face various complexity of operations necessary to carry out the deal.

What Is a Merger?

A merger is when you combine two separate businesses and create a new firm. Executive boards of both companies get together and create a combination, i.e., the terms of a merger. Then, they present the idea to shareholders and seek their approval.

Mergers are rare, especially when compared to acquisitions. This is because it’s not easy to find two companies of relatively the same size and market power that want to combine their efforts and create a new entity.

Although there are examples of one of the merging companies retaining its name, the new legal entity needs a new business name, and the general practice is to come up with something different.

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Types of Merger

There are five most common types of mergers:

1. Conglomerate—Two companies that have nothing in common and compete in different markets merge with an aim to extend product lines and increase revenue streams
2. Vertical—Two companies that operate in the same industry but at different supply chains merge operations. This is mostly done to increase synergies (e.g., a beer brand merging with a bottling company)
3. Horizontal—A merger between businesses in the same industry, often offering the same product or service
4. Product extension—Includes two companies that produce different products in the same market, allowing them to offer related (but different) products and increase their scope
5. Market extension—A merger between companies that operate in different markets but offer the same products. For instance, when a bank merges with a foreign bank to access another country’s market

Note that, in reality, most of these mergers happen as acquisitions, with a bigger, wealthier company adding the smaller one to its portfolio. For instance, an automobile company can do a vertical merger with a parts supplier, but it’s far more likely it would end up being an acquisition.

What Is an Acquisition?

A far more common of the two, an acquisition is a transaction in which a larger company purchases the target company and absorbs it entirely. While the purchased company can retain its name (mostly due to marketing purposes), it ceases to exist in legal terms.

Unlike with mergers, the acquiring company doesn’t need to change its name or its structure.

Types of Acquisition

The most common types of acquisitions include:

• Horizontal
• Vertical
• Conglomerate
• Congeneric

The first three are identical to mergers of the same type. A congeneric acquisition refers to an acquisition where the acquiring and the selling company have different products but the same target audience. For instance, a trademark-searching company can acquire a UCC-searching company and expand its portfolio.

Merger and Acquisition Differences—Recap

Check out the table below for a brief overview of the major differences between the two terms:

Conclusion

You can look at mergers and acquisitions as a shortcut to success, but they can be a shortcut to your failure if you don’t do it right. Between 70% and 90% of all M&A transactions fail.

While they come with great benefits and let you bypass the process of growing a successful company from the ground up, you should be diligent and not rush into a decision that might cripple your business. Take your time, consider all the risks, and try to have realistic expectations. If all goes well, your market presence (and revenue) will soar.