Management · July 17, 2020

Understanding the Basics of the Merger and Acquisition Process

Any industry can face challenges to growth and longevity due to advances in technology, changing consumer preferences or competitive pressure to control costs and increase profits. In many cases, acquiring or merging with another company may be the most efficient way to increase distribution reach, enter a new market or add new products.

The terms merger and acquisition are often referred to together as M&A or used interchangeably, but they carry distinct meanings. An acquisition can be the purchase of an asset, such as a factory, technology, an operating division or an entire company. When a buyer purchases an entire company, they generally take the majority stake in that company. Mergers happen when the companies are combined. Either they're absorbed into one another to make a new company, or one ceases to exist, with its operations potentially becoming part of the other.

Mergers and acquisitions can take on a variety of structures, largely depending on how the deal is initiated or financed, whether it's with cash, stock or a combination. In a traditional merger, one company may initiate or drive the process, but there's no distinction between buyer or seller among the two companies.


Finding the optimal strategy for growth

Companies decide to initiate mergers or acquisitions for a variety of reasons. Overall, it's about achieving the best fit for the business strategy. In some cases, the financing terms could be more amenable than those required to finance organic internal growth. Or perhaps internal growth could take too much time or result in lower valuations.

The merger and acquisition process typically requires a significant amount of time and company resources. The decision to target and purchase another company should be strategically planned, carefully weighing elements like the internal capabilities of your business and competition in the industry.

Once your organization decides to explore a merger or acquisition as part of a growth strategy, the next step is to target a company for the right fit. First, make sure you're clear on the benefits your company hopes to realize with the transaction. Carefully consider the potential target's market position and scalability potential, and seek to understand how the deal will affect the combined companies in the long run.

Pricing and value

Mergers and acquisitions can hinge on the pricing and value of the target asset. If a target company's shares are publicly traded on a stock exchange, the process can essentially involve multiplying the company's stock price by its outstanding shares. Pricing and valuing privately held companies can be more challenging. Because their shares aren't publicly traded, several factors can impact the outcome of the offer price negotiations, including:

  • Whether the deal is a strategic acquisition or merger versus a private equity purchase
  • Deal financing options available
  • Licensed intellectual property involved
  • Valuations used in the most recent financing rounds
  • Financial projections and historical performances
  • How comparable firms have been valued (multiples of revenue versus multiples of EBITDA)
  • Recent sales prices of shares

The presence of multiple interested parties, as well as industry structural shifts, can affect pricing, too.

Risk management and due diligence

As deals are typically financed by stock and loans, consider how economic conditions can impact the transaction and long-run success. Interest rates and financial market events can alter the dynamics. An economic slowdown can be an opportune time to get a bargain on the price of a company that is becoming illiquid. However, it's also essential to carefully review the cash flow and expenses of that company and evaluate the benefits of the acquisition at a moment of economic uncertainty.

Even with the best merger and acquisitions deal, issues can arise at any point. Sometimes, a problematic deal goes through, but with a reduction in shareholder value. Be prepared to manage risks both pre- and post-transaction.

Start with prioritizing a commitment to due diligence. This should involve a thorough examination of not only contracts and other corporate documents, but also the corporate history, mission, values, culture and intangible assets. Careful review of these factors may help not only prevent roadblocks but also uncover new opportunities to realize added value from the merger or acquisition.

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This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.