Acquisitions and Mergers Processes

Executive Summary

For a long time businesses have enhanced their growth through various methods and one way in which they have done this is through acquisitions and mergers. Reed (2007) argues that companies merge to gain competitive advantage over their rival companies in the market. Through mergers and acquisitions, businesses have been able to diversify their product lines and market targets. However, mergers and acquisitions have not always worked towards the success of the companies and there have been cases when companies have collapsed after merging. Therefore, it can be noted that a firm must establish a proper strategic planning model before engaging in mergers or acquisitions.

This study brings about a clear distinction between mergers and acquisitions. Many people tend to use the two terms synonymously whereas they have different meanings. The distinction between the two concepts also brings in the idea of the hostile acquisitions. The study also looks at the various steps that should be followed for a merger to be successful which begins with valuing the company involved and ends with closing the transaction and acquiring the business.

As part of making an appropriate decision whether to merge or not, the study notes the right time when a company should consider a merger. This means that proper information should be obtained before the management of a company merges so that it is able to accomplish its objectives. While determining the success of a merger, a company should also carry out a wheel of opportunity test and the fit test as well. These are some of the tools used to establish how effective a merger would be to one company over another.

The strategic planning process is also illustrated and it shows how firms use their strategic plans to fulfill their mission and achieve the desired vision. There are various levels of strategic planning in any business and these determine the extent to which a business has prepared itself to acquiring another business. The company’s board of directors and the management play a key role in enhancing the achievement of the firm’s desired objectives through the strategic planning process and it is important to note that the board’s commitment to the company’s plans will be a factor towards success.

The study also takes into perspective the financial instruments that are used by firms to finance mergers and acquisitions and this mainly emphasizes on debt and equity financing. Due diligence process is one stage towards ensuring an effective merger is created. It means the factors that one has to take into consideration before making the most appropriate decision whether to merge or not. The due diligence process follows different steps and there is also a checklist of that which must be presented by the target company before an acquisition or merger is made.

The process of a merger also involves the post merger and divestitures policies that should be taken into consideration as well. Since not all companies succeed in mergers, it is important that lessons learnt from a previous merger are used as a merger to making a decision whether the company should merger again or not. Hence, the companies’ own experiences play a major role in coming up with the most appropriate decision in respect to mergers.

Introduction

Distinction between a merger and an acquisition

Even if the terms mergers and acquisitions follow similar principles, they have different meanings. Both mergers and takeovers act on similar strategies; they combine two different companies to form one legal entity. The aim of both mergers and takeovers is to improve the company’s performance and promote long term profitability. The motive behind both mergers and takeovers is to boost their economies of scale, ensure more sales revenue and broaden its market share as well as increase tax efficiency. However, the strategies through which these acquisitions are made are different (Reed, 2007).

Acquisition occurs when one company takes over another and takes possession of ownership of the company. The acquired company ceases to exist and the new owner continues carrying on its activities. In such a situation, the acquired company ceases to operate and all its shareholding capital is taken by the acquiring company. A merger on the other hand takes place when two companies, which are in the same line of production, mutually agree to combine their businesses and form a new company rather than operate as two different businesses. Both of the company’s stock capital is given away and the new company trades in a new stock capital.

The purchase of a business can also be said to be a merger when the management in both companies agree that combining the two companies is in their best interest. However, when companies combine in an unfriendly manner and the target company is not willing to be acquired this is regarded as an acquisition. Therefore an acquisition can be friendly or hostile but a merger is a friendly combination of companies.

A hostile takeover is normally resisted by the firm to be purchased. It is characterized by the acquisition of a firm that is at a lower level of production than the one acquiring it, or a company that is larger than the one being acquired. The larger company may initiate a hostile takeover where unlike in a merger, the companies being combined in a hostile takeover may not be compatible. The larger company buys the smaller company when there is resistance from the management of the latter (www.economywatch.com).

Basic steps to successful merger

The following steps need to be followed for a company to be able to make value from the merger (Rock, 1993):

1. Valuation: Both companies which are merging must know the value of their businesses. Valuing a business is sometimes a complex procedure and requires a deep understanding of the prevailing market conditions, business finance strategies and the major accounting principles. The management must be aware of an experienced merger.
2. Exit strategies: Once a business has been valued, it is important that the management determines the most appropriate time to merge. The most appropriate time to make a sale is when the business is performing. Therefore, proper timing must be made to make a merger create value.
3. Match making: The business identifies the right business to merge with and this means that there must be proper understanding of the current market situation and the ability of the prospective buyer to effect the sale.
4. Negotiation: When the company identifies the right business to merge with, negotiations of the transaction takes place until when an agreement is reached.
5. Due diligence: The due diligence process facilitates the flow of the documents of the two companies and also ensures that the needs of both the buyer and seller are met.
6. Closing: The transaction process is then closed after the two parties have agreed on the terms of sale and the business begins as a new venture.

When would a company consider a merger?

With the high competition in the current markets, many firms are opting to merge with those other business that are trending their in the same markets. Merging has worked effectively towards promoting growth especially for the small businesses. The market trends have been unstable and businesses are finding the idea of product development challenging. They prefer to expand the size of their firms through combining with other firms in order to enhance expansion of their business activities (Gole, 2007).

Business acquisitions have in the recent times overtaken the processes of the IPO markets and for many firms the market is taken as a risky venture. They feel that acquisition will guarantee them of long term growth unlike investing in the initial public offers. This is especially so with the case of upcoming businesses which do not have enough capital to compete with the large companies in the IPO markets.

Bruner (2004) notes that mergers and acquisitions are also considered effective when firms are willing to enter new markets. The acquiring firms are normally ready to pay premium prices in order to gain access to new markets for a product produced by the target company so as to diversify the acquiring company’s line of production. Companies also consider acquisitions as a way of expanding the customer base and to provide a stronger corporate base.

The purpose of the wheel of opportunity and fit chart

To be able to make the right decision on buying or selling of a business, it is important that the management performs a wheel of opportunity test and create a fit chart. These strategies enable a firm to know the strengths and weaknesses associated with mergers and acquisitions and the ways in which a firm can use the strengths to enhance growth and the weaknesses to develop new ideas. The strategy also helps firms to be able to identify any alternative opportunities that may arise as the acquisition process is taking place (Reed, 2007).

Analysis of the strategic planning process

Strategic planning has been used by business enterprises as an effective tool towards success. The importance of enhancing strategic planning for mergers and acquisitions is an aspect that has for a long time been reviewed and it has been found out that most managers strongly advocate for these strategies as an effective way of building a company long term financial growth. According to a study carried out by financial analysts, it was found out that most mergers and acquisitions had a strong and clear strategic plan for the success of their merging or acquisition. The study also found out that mergers and acquisitions were one of the key techniques for promoting organizational growth (Gole, 2007).

According to Bruner (2004), the vital role of strategic planning in mergers and acquisitions is to enhance growth in an organization and since growth is the key reason for mergers and acquisitions, a proper strategic planning process must therefore be implemented.

The path to strategically fulfill a company’s mission and reach a vision

It is important that before undertaking any acquisition or sale of a business enterprise, critical analysis of the prevailing factors is carried out. There are great risks associated with purchasing or selling any form of asset. When acquiring a business enterprise, one must carry out certain procedures that will help them have a better understanding of the venture that they are getting themselves into. This means that thorough planning is a key aspect if a business or individual wishes to obtain the best value in the enterprise acquired (Bruner, 2004).

Mergers and acquisitions are focused towards achieving specific goals and objectives and before a company undertakes a merger, it sets a mission and vision which will be used to create a focus to the goals set. Sometimes companies may not achieve its mission mainly as a result of poor strategic planning. Therefore, for companies to be able to fulfill their mission and achieve their desired goals, the following must be observed (Gole, 2007):

1. Proper strategic plan integration: For a merger to accomplish its mission, the strategies that the companies were following when they operated independently need to go through a transition. A successful merger would require expertise to adjust the strategies and focus them to the firm’s vision.
2. Development of a new team in management: The mergers need to be able to create a competitive advantage in the market structure over other firms and therefore, the management needs to be re-designed so that the two can work together as one team and promote the success of the merger.
3. Create a roadmap for the merger or acquisition: This is an in-depth planning strategy that is aimed at helping the merger to be able to cater for the needs of its investors and other parties and the needs of the company as well. Once the needs of the company are fulfilled, the acquisition will be focused on reaching for the companies’ vision and its intended goals and objectives.

The vital role of a company board in strategic planning

Rock (1993) argues that, the company’s management must make critical commitments to each other during the planning process in mergers. It needs to establish those factors that will promote the growth of the company and must also commit itself fully to ensuring that the strategies implemented do not fail. Hence, the board must:

1. Understand that the growth of a firm is a long term goal and requires long term commitment.
2. Support fully the increased innovation that is as a result of merging.
3. Implement all relevant changes that are necessary for the company to focus and achieve its mission.
4. Put in mind that there is no single strategy or plan that has been implemented which will cause financial loss. Hence, committing the company’s strategies towards positive ideas will make the firm a clear success.

Hence, it is important for the company’s board to know that even as it takes into consideration the progress of the new company’s capital structure, it ought also to commit itself in the internal activities that will enhance proper strategic planning.

Financial instruments

Modes of financing in a merger or acquisition

According to DeThomas (1992), there are different ways in which mergers and acquisitions can be financed. An acquisition can be financed by borrowing money in respect to the value of the assets that the firm owns or alternatively, on the value of the assets and business of the target company. Mergers on the other hand are financed through stock swaps or by public issue of new stock to pay the shareholders of the target company. Mergers and acquisitions may also be financed through funds borrowed from banks and other financial institutions.

Financial sources of equity and debt financing

A business must develop appropriate methods of financing the acquired firm and this includes obtaining a sufficient amount of money that will enable it to purchase the target company together with its working capital. The equity of a company represents the entire business’s ownership and there must be appropriate sources of financing equity for the business to survive. Equity holders in a merger normally do not receive any return whenever the equity has been financed until all the debt has been repaid or has been fully secured (Lindsey, 1986).

The main distinction between debt financing and equity financing is that debt financing is a strategy which involves borrowing money from a lender with an agreement that the money will fully be paid back in the future, normally at an interest. Equity financing on the other hand requires that the money loaned does not have to be repaid. Instead, the investors take possession of part of the company’s ownership in exchange for the money. Hence, the most common source of financing equity is from the company’s share capital which also acts as security for the loan (Lindsey, 1986).

Hamilton (1990) notes that, there are various sources of debt financing in a merger and these include private placement of bonds and public development bonds, investment in convertible debentures and the leveraged acquisitions which are created through bank debts. However, the most common source of debt financing is through a normal loan. There are the long term loans which are repaid after a relatively long period (at least more than one year) and the short term loans that are repaid after a period not more than two years. They are normally secured by collateral like real estates, stocks and bonds or the company’s other assets.

The complexity of obtaining an appropriate source of debt financing in mergers

According to Hamilton (1990), a lender will want to be assured that the business that it is lending money to is able to repay the debt once it has matured. Therefore, the lender must take into consideration several aspects of a merger and this normally brings about complexities while establishing the most appropriate source of debt financing.

Banks and financial corporations are the major source of financing mergers and acquisitions. The loans obtained from these institutions normally charge high rates of interest for mergers than for the small business enterprises and these loans are secured by the company’s assets which can easily be seized if the company fails to repay. On the other hand, a merger may incur severe cash flow difficulties if it engages in too much debt financing that it may not be able to expand or if it does not create good working relationships with the prospective lenders (Lindsey, 1986).

Due diligence process

Rosenbloom (2002) argues that, firms and other business enterprises must develop a systematic approach that will ensure they take reasonable care before entering into a merger or an acquisition. This means that the critical financial and legal factors that affect the mergers should form the basis to making the decision whether to merge or not. This is referred to as due diligence.

According to Rosenbloom (2002), financial and legal due diligence determines the potential value of an acquisition deal in respect to price while strategic due diligence finds out whether the entire acquisition process is realistic and worth. It ensures that no two deals are treated the same because each transaction has its own distinct business characteristics and hence the composition of the due diligence in each of the deals ought to be treated differently.

Basic steps in due diligence process

Howson (2003) identifies the following steps to be taken in the due diligence methodology of mergers:

1. Baseline starting process: This includes carrying out a briefing to the management on the financial and other aspects that are likely to be affected by mergers. Interviews may be carried out to find out the strategic planning process that the management wishes to undertake to ensure that the company established through merging succeeds.
2. Assessment of market structures: The firms identify the prevailing market conditions and growth trends which are likely to impact on the merger. This may be done through interviews to market experts or the consumers.
3. Establishment of the major competitor strategies and technology trends: This is important because the success of the mergers is based on how well it is able to gain competitive advantage over other firms. The company must know the prevailing technological advancement so that it can compete well for its products.
4. Assessment of the internal skills and capabilities: Once the external market situations have been taken into consideration, an analysis of the internal company capabilities is followed. This includes determining whether the internal company’s capabilities are able to support the prevailing trends.
5. Business plan review: A review of the intended and actual sales, costs and the sources of financing is then undertaken to ensure that the plan supports these aspects. This also includes reviewing the technology existing and determining whether this technology actually supports the investment plan.

Once these steps are followed, the firms are able to make the mergers and acquisitions fall within their ability to implement them and enhance growth.

Due diligence checklist

Whenever a business is anticipating a merger, a thorough due diligence analysis must be carried out. The acquiring company will want to know whether the business it is intending to acquire is worth investing in and therefore, the following checklist of information as well as documents will be reviewed (Howson, 2003):

1. The firm will want to know the legal aspect of the Target Company and documents like the Articles of incorporation, minute books, the organizational chart, list of shareholders and other relevant legal documents like copies of agreements and a list of all those states where the company is authorized to do business.
2. Statements showing the financial information of the company. These include the audited financial statements for the preceding three years, the auditor’s letters for the preceding five years, capital budgets, schedule of accounts receivables and payables, among others.
3. A list of the physical assets including the real estates. These are the schedules of fixed assets, title deeds, leases of equipment and real estates and a list of sales and purchases of the major assets made during the last three years.
4. All copies of government permits and licenses.

Post mergers and divestitures

According to Carleton (2004), mergers and acquisitions enable organizations to learn from their experiences. In reality, not all businesses benefit from mergers and acquisitions and quite often firms that have experienced minor losses in previous acquisitions will be encouraged to learn from their performance and aim at being better in the subsequent acquisitions. On the other hand, those firms that have either made a major success or failure will hardly be able to learn from that experience. According to a study carried out, it was noted that those firms that frequently engage in purchasing new firms are more likely to be successful in subsequent purchases than those who are not. This implies that frequent purchases will increase opportunities for business success since the firms gain experience on means of avoiding those deals that are too risky.

Other critical analyses noted that firms are more successful in mergers when they acquire those other firms in which they have common business lines. This shows that there is more to acquisitions than just gaining experience. On the other hand, those firms that make several acquisitions at one time without creating reasonable durations in between the acquisitions are not as successful as those who do not frequently make purchases. Hence, subsequent acquisitions ought to be separated by a specific time period which is neither too long nor too short. When the duration is too short, the firm may have time to learn lessons from its previous acquisition and when it is to long, the firm will have learnt the lessons and forgotten them by the next acquisition (Gole, 2007).

Gole (2007) argues that having an unsuccessful merger can act as a foundation towards succeeding in future mergers. This is because the firms will be able to learn from their previous mistakes and make efforts to improve in the other mergers. However, those firms that were successful in their previous mergers will tend to be ahead of the unsuccessful mergers even in the future.

All these arguments are focused on the post merger requirements that must be considered for a firm to achieve success, which are: business strategy, due diligence and post merger integration.

The complex issues in the Pay Integration and benefits of the Merger Plan

According to Gole (2007), the major barrier to successful integration in a merger is cultural incompatibility. By ignoring or undervaluing the key aspects related to business transactions in form of mergers and acquisitions, the major positive characteristics that were present in the assets are likely to be lost and the buyer may take a different perspective of the merger. Mergers and acquisitions are soon becoming important factors in the business strategies. It has been noted that in 1998, the value of mergers and acquisitions all over the world went up to $2.5 trillion, which was 50% more than the value the previous year. The figure continued to rise in the succeeding years. However, despite this entire rise in their value, only about half of the mergers and acquisitions have succeeded. Most companies show that success can only be achieved through persistent mergers so that overall performance can be established.

The key strategies and practices used by major companies during corporate strategic planning, pre-merger planning and post-merger implementation, show that mergers can be a success. However, the process may not be easy and mergers are a risky and challenging decision that must be critically planned. The decision to carry out a merger must be well challenged before companies commit themselves. They should mainly focus on the average contribution of the financial returns and risks involved. Even with critical planning, proper activities and focus, the success of mergers is not guaranteed and firms should know that implementing the best practices should facilitate chances of merger success and help avoid major pitfalls (Carleton, 2004).

Conclusion

In conclusion, it can be seen that most companies have realized that one of the best way to move forward in the business is to expand their ownership boundaries through mergers and acquisitions. Others feel that separating the ownership of a subsidiary company or a department through sale results to greater benefits. Mergers create synergies and enhance economies of scale and also expand business operations hence cutting on costs. Mergers have been seen to be an effective way of enhancing a company’s market power and this aspect is being used by investor to make the best decision from the diverse markets.

In contrast, de-merged firms normally enjoy more efficient operating performance through the establishment of better formulated management strategies. Therefore, it can be argued that a firm’s capital can promote growth both through original growth of firms and through business acquisitions and mergers. Mergers and business acquisitions are in different forms and investors need to consider the complex issues that are involved in the acquisitions. On the other hand, firms and business enterprises need to make the best decisions before engaging in the acquisition process and they can learn from their own experiences on how to enhance growth and success through mergers or acquisitions.

References

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Hamilton, B. Financing for the Small Business. U.S. Small Business Administration, 1990.

Howson, P. Due Diligence: The Critical Stage in Mergers and Acquisitions: Gower Publishing, Ltd., 2003.

Gole, W. Mergers and Acquisitions: Business Strategies for Accountants: USA; John Wiley and Sons, 2007.

Lindsey, J. The Entrepreneur’s Guide to Capital. Probus, 1986.

Rosenbloom, H. Due Diligence for Global Deal Making: The Definitive Guide to Cross-Border Mergers and Acquisitions, Joint Ventures, Financings, and Strategic Alliances: California; Bloomberg Press, 2002.

Rock, M and Sikora, M. The Mergers & Acquisitions Handbook: New York; McGraw-Hill Professional, 1993.

Bruner, R. Applied Mergers and Acquisitions: USA; John Wiley and Sons, 2004.

Reed, S, Lajoux, A and Nesvold, P. The Art of M&A: A Merger/Acquisition/Buyout Guide: New York; McGraw-Hill Professional, 2007. Web.