What Really Happens During a Merger or Acquisition (M&A)
Introduction
There are many questions surrounding the actual transaction of a merger and acquisition (M&A). When a business is acquired it is purchased by another company. The acquirer takes control of the acquired company completely, and the acquired company ceases to exist as a separate entity and instead its properties, assets, etc. become part of the operations of the acquirer.
For example, when Disney acquired 21st Century Fox in 2019, Fox's film studio and all the associated assets, intellectual property and other items associated with the studio were acquired and subsequently became part of Disney's operations.
Mergers, on the other hand, are a different type of transaction. Mergers occur when two companies agree to merge and combine their resources and become a new legal entity. Generally speaking, the two companies will be of similar size and market capitalization. In many instances, the merger will be called a "marriage of equals."
The merger that took place in 1999 between Glaxo Wellcome and SmithKline Beecham resulted in the formation of GlaxoSmithKline (GSK), one of the largest pharmaceutical companies in the world.
Typically when two companies engage in an M&A, it will garner significant amounts of press and media attention. News releases will include thoughts of grand aspirations for the future and will include statements about how this transaction will create greater shareholder value for the combined company after the deal closes. However, beneath the surface of the hype are numerous difficulties and challenges that both companies will face during the M&A transaction. M&A transactions can create a tremendous amount of upheaval and uncertainty for both organizations, due to the change in operations from the boardroom to the back room and everywhere in between.
Phase 1 covers the first moves and early talks
The initial discussions do not have an official starting point. At the beginning of Phase 1, there is usually a need for a solution or opportunity that may include, but is not limited to, the following; entering a new market or acquiring advanced technology, or leveraging acquisitions to expand their market share or create efficiencies in costs. Additionally, companies may wish to create more diversification through investment income.
Once the opportunity or need is identified, the Corporate Development Team(s) will start to identify prospects to build a long list of target(s). After building a long list of prospects, the Corporate Development Team(s) will create a short list of qualified targets and contact those organizations.
The first step was to identify the potential buyer's and seller's values. This could have been through informal discussions between the CEOs of both organizations, or it could have been in a competitive environment where the buyer went directly to the shareholders and attempted to acquire shares in the target organization without going through the executives of the target organization. In informal situations, the parties might have decided to meet under NDA to learn more about each other before proceeding to formal negotiations; however, in these situations, all parties will keep their intentions and proprietary information confidential until the end of negotiations.
Phase 2 dives into due diligence. It feels like a deep checkup on the target
When a buyer is interested, they move forward with due diligence to find out the actual condition of the target company. The reason for this is to get a full understanding of the potential target's health and fit, not just a basic review but a in-depth assessment into all of the factors involved and how everything fits together.
A financial due diligence review will evaluate all financial aspects of the target company. Experts will examine how the target recognizes revenue, evaluates debt and tax liabilities, looks at earnings quality, removes or adds one-time wins and provides a better understanding of earnings quality over time.
A legal due diligence review will review key legal documents such as contracts, lawsuits, employee agreements, etc. Legal due diligence will look for potential hidden risks such as pending lawsuits or expiring patents.
A commercial and strategic due diligence review will evaluate the target's market position. A buyer will look at whether the target's position in the market is valid, the presence or absence of a diversified customer base, and the strength of the supply chain, i.e., the overall commercial and strategic due diligence review should confirm the buyer's rational rationale for wanting to acquire the target.
An operational and technical due diligence reviews will evaluate the target company's manufacturing facilities, equipment and processes. IT due diligence will evaluate the target's information systems and how well they integrate into each other. An example of this would be a buyer who uses SAP and the target uses a different information system like Oracle. The two systems will not be compatible with each other, unless the buyer's plans to integrate them make it possible.
People factors and culture are often overlooked. It's easy to assume that all companies have similar pay set ups and approaches to leadership. You might have one company that has a top down approach, while another has a flat approach; the end result will be mismatched expectations, resulting in a failed contract later in the process. At this point, sellers must protect themselves by being transparent with buyers, yet ensuring their company's continued operation, and also protecting their company's interests in case of a failed deal.
Phase 3 handles pricing talks and deal setup
Due diligence is the process through which a buyer determines the offer price for the business. The buyer's model will be modified according to the findings of the due diligence investigation, and will combine quantitative data with qualitative information. For example, discounted cash flows and multiples of comparable firms can also help inform a buyer's price. The results of the due diligence process should yield a range of potential offers for the seller.
Negotiations begin after the due diligence process. Although the total price is important to the seller, the structure of the deal will have a more significant impact. Specifically, a deal's structure will influence the relationship between the buyer and seller and how the seller's assets are transferred to the buyer. There are also various payment options available to the seller. Cash payments may be available immediately; however, the seller will be required to use its reserves to pay the taxes on this type of payment. Conversely, stock payments will dilute the-value of ownership; therefore, cash is preferred to reduce tax liability.
There may be personal preferences regarding how the governance of the business is structured, such as who is to be the CEO, and how board seats are divided. In addition, target company executives may be appointed to high-level positions after the acquisition of the target company. The target company's executives are highly political.
Written agreements, such as the letter of intent or memorandum of understanding, outline basic terms. A letter of intent does not legally bind either party to the agreement; however, it does provide assurance that the buyer is committed to purchasing the seller's business. Letters of intent often include exclusivity. Final contractual provisions will be negotiated after the formation of the letter of intent.
Phase 4 brings the signing and public reveal. Regulators wait after
The time frame between these two events is determined by the regulatory bodies that need to confirm the laws that the agreement falls under.
Once the contract has been signed, news will quickly circulate. Press releases will indicate an increase in growth potential and more partnerships with other companies. The contract also creates an added incentive for the top players in the market, as well as for employees on the inside preparing for the negotiations of the contract.
The next step is obtaining regulatory approval prior to the closing date. Regulatory bodies such as the Federal Trade Commission (FTC) and the Department of Justice (DOJ) for the United States and the various bodies in the European Union must review the proposed merger or acquisition and find that it does not create an anti-competitive situation in their respective countries. Other countries may also have regulatory bodies review the merger or acquisition and collect a great deal of paperwork to see if, due to the merger or acquisition, a potential competitor may be created due to the decrease in the amount of potential competition.
Although most mergers and acquisitions will not face any significant obstacles to their completion, delays in the approval process can lead to many employees of both companies losing their focus on their current jobs, competitors using this weakness as a means for leveraging their sales, and high-profile employees discussing exit strategies. Furthermore, the companies involved in the merger or acquisition will have time to plan and design ways to combine their operations; however, until the merger or acquisition is completed, they will continue to work slowly.
Phase 5 hits on close day. Blending starts for real. Value wins or slips here mostly
A new beginning starts on the first day with fast-paced work. For the first 100 days, companies must execute many things quickly and be prepared for large numbers of layoffs that will happen frequently during those first 100 days; also, new leaders will come in and out, logos will change, and leaders must use clear language with each other to prevent gossiping about the changes happening.
These functions will all become one in terms of daily operations and communication; Finance, HR, IT, Sales, and Operations will begin working as one entity, so each will use the same software, with all sales groups using the same commission structure for each brand and each brand having its own logo. Choices related to the cultures that each brand represents will not only create financial differences between brands (due to the various ways each functions) but will also create cultural differences.
Synergies will search for "real" synergies to create financial savings and increased revenues; office closures will generate savings, and supplier relationships will become more consolidated; there will be large numbers of staff reductions that will take place to create the necessary financial savings and staffing levels for increased sales. All of these changes will be closely monitored by senior management, who will use key performance indicators (KPIs) to measure employee productivity and overall company performance.
The blending of cultures will create the greatest challenges and opportunities for success. Leadership should be proactive in identifying potential areas of conflict and developing strategies to prevent or resolve them. The lack of intervention could result in a battle for market share, a battle over risk-taking, and a battle over the different work conditions of all of the different employees. Additionally, if companies do not address the differences in internal cultures, they will experience a slow build-up of conflicts and misaligned cultures. Talented employees will leave. Innovative ideas will stagnate. Operational efficiencies will freeze. Companies will "lose" in the marketplace due to a slow build-up of these conflicts.
The human side adds hidden strain.
Focus is on money and operations. Emotions are high below surface. Concern permeates. Team members lament against departed colleagues and previously established patterns. Routine disrupted. Remaining team members feel bad for continuing on. Division has been created between winning and losing sides. Resentment increases. Motivation wanes as infighting diverts team focus from the clients. Those that leave take their experience with them. It is painful.
Leaders are under fire, too. Wall Street is closely watching. Employee stress continues to mount. Power plays are rampant throughout the organization. Leaders are trying to do all of this at once.
Types of Mergers and Acquisitions in Structure.
The following examples demonstrate that mergers/acquisitions may fall into other categories according to the strategic relationship between companies.
1. Horizontal Merger/Acquisition
• Definition: A merger/acquisition between businesses that are competing directly with one another in the same stage of production and industry.
• Objective: To take market share, reduce competition and take advantage of economies of scale.
• Example: The merger of Starwood Hotels and Marriott to form the largest hotel chain worldwide.
2. Vertical Merger/Acquisition
• Definition: A merger between companies at different levels of the same supply chain in the same market (for instance, a manufacturer and a retailer/distributor).
• Objective: To have a secure supply of materials, exercise cost control and increase business efficiency.
• Types of Vertical Mergers:
Forward Integration: A Manufacturer purchases a retailer or distributor (for instance, a retail company purchases a shoe manufacturer).
Backward Integration: A Manufacturer purchases its Supplier (for instance, an automaker purchases a tire maker).
3. Conglomerate Merger/Acquisition
• Definition: A merger/combinations of different businesses that do not have a direct connection with each other in terms of their operational focus.
• Objective: To reduce risk and revenue concentration.
• For example, Berkshire Hathaway has acquired many companies in different industries (insurance, railroads, candy, energy, etc.) to form a large conglomerate.
4. Concentric Merger
• Definition: A merger between two firms that operate in related industries, but do not sell competing products. Examples include companies that share technologies, marketing channels and common customers.
• Goal: To be able to cross-sell products, and expand market reach, into new marketplaces.
• Examples:
Market Extension: An eastern bank buys a western bank.
Product Extension: Proctor & Gamble (which produces household products) acquired Gillette (which produces personal care items). Both target the same customer base, but produce different types of products.