Determining the best course of action for growing a business is a key challenge faced by corporate finance professionals. Is it better to develop organically by investing in projects within the company, or expand by acquiring other firms?
The latter option—inorganic growth—is achieved through mergers and acquisitions. And it’s one that many firms are currently pursuing.
According to a 2019 survey by Deloitte, 79 percent of US corporations and private equity firms expect to see an increase in the number of mergers and acquisitions over the next 12 months.
Despite this optimism, these deals can be fraught with complications. Before looking at some of the potential risks of these transactions, it’s important to understand what mergers and acquisitions are and how they differ.
What Are Mergers and Acquisitions?
Mergers and acquisitions (M&A) refer to the process of consolidating companies or their assets. The terms merger and acquisition are often used interchangeably, but have different meanings.
A merger occurs when two companies agree to consolidate into a new entity. For instance, Company A and Company B agree to come together to create a new entity, Company C.
One example is the merger of Exxon Corporation and Mobil Corporation in 1999. The two companies were the leading oil producers at the time and created a joint entity under the name Exxon Mobil Corporation.
An acquisition is a process whereby an existing company purchases and assumes ownership over another firm or asset. For instance, Company A acquires Company B and the two companies continue to operate as an existing entity, Company A.
A well-known example of an acquisition took place in 2017 when e-commerce giant Amazon purchased Whole Foods for $13.7 billion. As a result of the acquisition, Amazon now holds ownership of Whole Foods and its assets.
Both types of M&A transactions can enable organizations to expand their reach and increase market share.
Examples of Mergers and Acquisitions
Mergers and acquisitions happen all the time. According to the Institute of Mergers, Acquisitions, and Alliances (IMAA), there have been nearly 800,000 such transactions worldwide, worth an estimated $57 trillion.
Some other well-known examples of mergers and acquisitions include:
- The Walt Disney Company’s acquisitions of various companies, including Miramax Films (1993), Fox Family Worldwide (2001), The Muppets (2004), Pixar (2006), Marvel (2009), Lucasfilm (2012), and 21st Century Fox (2019)
- Google’s acquisitions of YouTube (2006), DoubleClick (2007), and Waze (2013)
- The 2018-19 merger between CVS and Aetna
- The 2015 merger between Kraft FoodsGroup Inc. and the H.J. Heinz Company
The Risks of Mergers and Acquisitions
While mergers and acquisitions can lead to tremendous growth opportunities, they can also come with substantial drawbacks for the parties involved. Here’s a look at four risk factors associated with M&A deals and when they can arise:
Before the Merger or Acquisition
1. Lack of Due Diligence
Due diligence is critical to preparing for M&A transactions. When purchasing preexisting assets, it’s the seller who holds much of the information. Prior to the transaction, your company should learn as much as possible about the selling firm’s financials, contracts, customers, insurance, and other pertinent information to ensure that it has an in-depth understanding of the deal on the table.
Without a thorough information-seeking process, your firm could get caught up in obligations it’s not yet ready to assume, such as litigation issues and complicated tax matters.
2. Overpayment
Overpayment is a common pitfall of mergers and acquisitions. There can be a lot of pressure from several sides when preparing for such significant transactions. In addition to the seller, you may be getting urged by intermediaries involved in the agreement, as well as by teams within your own company. This could force your organization to overpay in order to simply push the deal through, rather than work out an arrangement that creates value.
After the Merger or Acquisition
3. Miscalculating Synergies
Several problems can arise if your organization completes a transaction with misguided notions about realizing synergies, or ways in which the two companies combined are more valuable than they are individually.
Firms often enter a deal overly optimistic about the impending payoff and underestimate how long synergies take to come to fruition. Consolidating workforces and operational processes takes time, and excess costs can be accrued if there are unrealistic expectations around when the integration will be complete.
Synergy miscalculations can also feed overpayment, as they may be rolled into the purchase price in order for your company to gain control over assets before it can fully reap the benefits.
4. Integration Issues
Significant integration issues can crop up after a merger or acquisition—both operationally and culturally. A merger or acquisition is a major organizational change with the potential to alter many of the underlying processes behind how both businesses operate.
If a detailed integration plan isn’t in place when a transaction is made, the companies involved in the deal may function separately for longer than anticipated, resulting in increased costs over time.
Different cultures may also pose a challenge. According to research by McKinsey, approximately 95 percent of executives say cultural fit is vital to the success of integration.
While one company may be more entrepreneurial and innovation-focused, the other may be more traditional and results-driven. If the transaction involves acquiring an international business, employees may suddenly find themselves coordinating with or managing a global team.
Without a robust integration strategy that takes into account the values, norms, and assumptions of each organization, collaboration issues may arise that impede efficiency and delay the consolidation process.
Navigating Mergers and Acquisitions
Mergers and acquisitions can be a boon to corporate growth. A common issue underlying many of the risks that come with negotiating M&A deals is the tendency to involve finance too late in the process.
The finance department is often perceived as the gatekeeper for capital allocation, and many business professionals tend to hold off on its involvement for fear of halting proceedings. However, the earlier you consider financial implications, the better equipped you can be to avoid the pitfalls commonly associated with mergers and acquisitions.
With a knowledge of finance and a keen understanding of the risks involved, you can help your company navigate these complex transactions and increase its market share.
Do you want to develop a toolkit for making smarter financial decisions? Explore our six-week online course Leading with Finance and discover how you can identify ways to create and measure value at your organization.
(This post was updated on April 27, 2020. It was originally published on July 25, 2019.)
