Why Companies Engage in M&A

Growth

Many companies use M&A to grow in size and leapfrog their rivals. In contrast, it can take years or decades to double the size of a company through organic growth. Organic growth means using cash on hand or financing to increase sales and marketing efforts to increase revenue. Organic growth requires much strategy to be able to manage that growth with resources including human resources.

Competition

Competition is a major motivator and is the primary reason why M&A activity occurs in distinct cycles. The urge to snap up a company with an attractive portfolio of assets before a rival does so generally results in a feeding frenzy of other acquisitions in hot markets. An example of frenetic M&A activity in specific sectors include dot-coms and telecoms in the late 1990s.

Synergies

Companies also merge to take advantage of synergies and economies of scale. Synergies occur when two companies with similar businesses combine, as they can then consolidate (or eliminate) duplicate resources like branch and regional offices, manufacturing facilities, research projects, etc. Every dollar saved goes straight to the bottom line, boosting earnings per share and making the M&A transaction an “accretive” one.

Domination

Companies also engage in M&A to dominate their sector. However, a combination of two behemoths would result in a potential monopoly, and such a transaction would have to run the gauntlet of intense scrutiny from anti-competition watchdogs and regulatory authorities.

Tax Purposes

Companies also use M&A for corporate tax reasons, although this may be an implicit rather than an explicit motive. This technique called corporate inversion involves a U.S. company buying a smaller foreign competitor and moving the merged entity’s tax home overseas to a lower-tax jurisdiction, in order to substantially reduce its tax bill.

Why M&A Transactions Can Fail

Integration Risk

In many cases, integrating the operations of two companies proves to be a much more difficult task in practice than it seemed in theory. This may result in the combined company being unable to reach the desired targets in terms of cost savings from synergies and economies of scale. A potentially accretive transaction could therefore well turn out to be dilutive.

Overpayment

If company A is overly bullish about company B’s prospects and wants to forestall a possible bid for B from a rival it may offer a very substantial premium for B. Once it has acquired company B, the best-case scenario that A had anticipated may fail to materialize.
For instance, a key drug being developed by B may turn out to have unexpectedly severe side effects, significantly curtailing its market potential. Company A’s management (and shareholders) may then be left to rue the fact that it paid much more for B than what it was worth. Such overpayment can be a major drag on future financial performance.

Culture Clash

M&A transactions sometimes fail because the corporate cultures of the potential partners are so dissimilar. Think of a staid technology stalwart acquiring a hot social media start-up and you may get the picture. However, if a strategy is formed to build a new company culture (before the transaction closes) this does not have to be a cause of failure.

In Closing

C-Suite Deal Makers is a boutique investment banking firm that provides M&A and capital raising services to early-stage and lower middle-market companies.
Deal Makers’ focus is working with companies to raise debt and equity capital, providing acquisition services, preparing and taking business owners through the process of selling their business, advising owners and companies with regard to their real estate strategies and transactions. and taking companies through the public offering process.