M&A Stages

By February 2, 2022Other

Introduction

Investopedia states the difference between a merger and an acquisition is that “a merger occurs when two separate entities combine forces to create a new, joint organization. Meanwhile, an acquisition refers to the takeover of one entity by another” (Investopedia). Whether merging or acquiring a company, the process takes anywhere from six months to multiple years. Many of you on this site may be going through this process either as a buyer, target, partner, or something else. No matter if you are looking to merge, acquire, or sell, the stages described in this article will help you understand what the process looks like.

To learn more about specific services on the buy and sell-side of M&A,  check out this article “M&A: Buy Side vs Sell Side.” Also, to learn more about acquisition strategy, go to “Acquisition Decision Making.” Lastly, for questions on whether to go through the process before an IPO, please read the “Pre-IPO Acquisitions” article.

Background/Overview

If you are reading this article, then you’re most likely researching ways in which M&A can help create “value” for the company. This value can take many different forms. How you want to grow the business and expand your value helps shape the way your company goes about its acquisition strategy.

Here are some of the ways your company can focus on creating value according to Tracy Farr- Director of Investment Banking at Lazard:

1. Synergies – Both from the revenue as well as the cost strategy sides. This synergy can be for both companies, or just the acquiring one depending on the strategy your company is pursuing.

2. Competitive dynamics – An acquisition can be defensive in nature like preventing a competitor from acquiring the same technology or customer base. It could also be offensive, which can sound like a revenue synergy, but often is difficult to quantify. 

3. Valuation arbitrage – An acquisition could be accretive and drive value on an EPS and value basis if the multiples are in such a way that it is EPS accretive without impacting or detracting from the PE or EV multiple.

4. Financial Engineering – Depending on how an acquisition is financed, you can drive value through your process.

5. Growth in the Entry vs Exit Multiple – This is less predictable and generally not “paid for,” but if you believe a business that trades at 8x today will trade at 12x in a few years, you can buy it, scale it up, and divest it later. 

6. Scale – Sometimes it can simply be to diversify your revenue, whether by product, customers, vendors, suppliers, etc.  Though it may not have direct synergies, diversification can reduce volatility of earnings, which can enhance value. 

7. Management or Talent – Building out managerial capabilities and talent through another company. This is not a common reason for M&A but is sometimes used as a transition tool.

(Farr, Tracy)

Stages

1. Develop an acquisition strategy

The purpose behind an acquisition is to create synergistic value between the two companies that wouldn’t exist without the combining of companies. Too many companies make the sad mistake of acquiring another company without carefully thinking through how the acquisition will create value. This mistake may lead to a net loss on the transaction. Of course, a short-term loss might be worthwhile if the combined company can subsequently gain market share, create cost savings, use an expanded product line to beat the competition, or create some other market value.

Acquisition examples

There are many great and not-so-great acquisitions happening all the time. One of the greats is the merger of Disney and Pixar. Or perhaps Exxon and Mobil, making a combined Exxon Mobil which is one of the largest oil and gas companies in the world.

Some well-known failures are the Sprint and Nextel merger and the AOL and Time Warner merger. The combination of Sprint and Nextel resulted in a culture clash, with most of the Nextel executives exiting the company and leaving it in shambles. AOL-Time Warner was a good idea—combine the Internet presence of AOL with the vast content library of Time Warner. But the bursting of the Internet bubble along with faulty operating decisions made by both companies ended up costing shareholders billions.

Read more examples about successful and failed acquisitions here.

2. Set the M&A search criteria

Like the strategy in stage one, this stage depends on defining clear company criteria to look for in potential M&A targets. Understanding your target company’s resources, capabilities, culture, and more will determine whether the acquisition is a profitable deal or not. In addition, it is important to be honest in identifying characteristics that your company does NOT currently have, characteristics that would be valuable in an M&A target.

Once the criteria are set, creation of a ranking system is important, not only to find opportunities that create value but also to find the most desired value.

Systems for identifying and screening acquisitions

Effective systems for identifying and screening acquisitions have four important properties. First, they must provide means of evaluating a candidate’s potential for creating value for the acquirer’s shareholders. Second, they must be able to reflect the special needs of each company using the system. Relying on checklists or priorities with supposed universal applicability is the surest possible way of placing an entire acquisition program in jeopardy. Third, they must be easy to use—but not overly rigid. Since most structured frameworks of analysis run the risk of promoting mechanical solutions to complicated policy issues, formal screening, and evaluation procedures must not be allowed to crowd out more informal, spontaneous contributions to the decision-making process.

Fourth, and perhaps most important, an effective acquisition screening system must serve as a mechanism for communicating corporate goals and personal knowledge among the parties involved. The analytic concepts and language inherent in such a system can significantly aid managers in implementing an acquisition program that is conceptually sound, internally consistent, and economically justifiable (Harvard Business Review).

3. Search for potential acquisition targets

Now that your company knows who to look for, it can begin searching for target companies. This stage is often combined with stage two (set the M&A search criteria) but maintaining this sequencing—first set the criteria, THEN search for potential targets—is still important. Many potential target companies can be watched, and a few may meet some of the criteria for acquisition, but only those that will either positively disrupt your market or synergize with your company should be deeply considered.

This stage is often where companies will engage advisors who engage with the company on a long-term basis all the way through the negotiations.

This step is combined with public and industry diligence. That includes due diligence into the industry as a whole and the different opportunities that might exist within that industry and your company.

4. Begin acquisition planning

This stage is for the buyer to learn more about the companies that fit the acquisition criteria to determine whether a combination makes sense. This stage may include the crucial step of reaching out to the company to find out whether this will be an agreement or a takeover.

Financing strategy and planning need to start early as it often takes time

5. Perform valuation analysis

If the initial contact goes well, the next stage is to gather detailed information about the target company with the objective of creating an accurate acquisition price. This valuation is greatly improved when the target company willingly provides detailed internal data to help with the cash flow forecasts used in the valuation. If the initial contact did not go well, a valuation still must be performed, but now the valuation is based on publicly available data, market multiples, and overall industry analyses.

6. M&A due diligence

“Due diligence is an exhaustive process that begins when the offer has been accepted; due diligence aims to confirm or correct the acquirer’s assessment of the value of the target company by conducting a detailed examination and analysis of every aspect of the target company’s operations – its financial metrics, assets and liabilities, customers, human resources, etc.” (Corporate Finance Institution).

Common reports include a quality of earnings report as well as assessments of the company’s assets, inventory, customer base, and more.

7. Negotiations

Once an initial offer amount is decided upon, the offer is presented to the target company, and the two companies continue to negotiate further. This process is often facilitated by an advisor such as an investment bank, accounting firm, legal, and more.

 The initial offer amount is often re-evaluated after the due diligence is completed before the final purchase.

Example: Facebook and WhatsApp

Facebook purchased WhatsApp for $22 billion in 2014. Both the target, WhatsApp, and the buyer, Facebook, had never done a deal this big before. They needed advisers to walk them through this acquisition process. The investment bankers on each side of this transaction earned about $40 million in fees in helping Facebook and WhatsApp make this large deal happen (LinkedIn Learning).

8. Purchase and sale contract

If no major concern arises during the due diligence phase, a final contract is agreed upon and signed by both parties. This step is combined with a public announcement of the merger or acquisition.

9. Finalizing financing for the acquisition

This step may seem out of order; however, it is not until after the deal has been signed that the financial details come together, and the deal is finalized with the purchase.

Finance the acquisition

There are many different ways to finance the acquisition, but here are six common ones. Deals often involve a mixture of multiple financing options from the list below.

  1. Equity only, no cash
  2. Cash or company profits
  3. Seller notes- Paying partially at the beginning and the rest over a period of time.
  4. Seller equity- Paying part of the company’s valuation up front and the rest in equity of the acquiring company.
  5. Debt financing through banks, institutions, private debt, direct lending, etc.
  6. Private equity firms or other investors.

10. Closing and integration of the acquisition

Now that the deal is closed, management gets to go through the very valuable and difficult process of integrating both companies. This process can either create value for both companies or be a costly endeavor.

Forbes goes over what is needed for a successful merger in this article.

Conclusion

This may seem like a simple process, but each of the ten stages can take months to complete. Even if you are not in the M&A process right now, completing the first two stages as a company will help save a lot of time in the future. That way when an opportunity presents itself, your company will have less difficulty moving forward. More articles outlining specific stages are still being written by the IPOHub contributors. If you wish to learn more about a stage, please email us and that will be the next article we publish.



Resources Consulted

https://corporatefinanceinstitute.com/resources/knowledge/deals/mergers-acquisitions-ma-process/

https://www.ilpabogados.com/en/the-10-steps-of-an-acquisition-mergers-and-acquisitions/

https://dealroom.net/faq/what-is-m-a-process-everything-you-need-to-know

https://www.investopedia.com/terms/m/mergersandacquisitions.asp

https://app.myeducator.com/reader/web/1748a/topic10/kz046/

https://www.forbes.com/sites/forbescoachescouncil/2020/02/13/7-elements-needed-for-a-successful-acquisition-integration/?sh=27a622f6b1c3

https://www.forbes.com/sites/georgedeeb/2020/09/04/the-top-6-ways-to-finance-a-merger-or-acquisition/

https://hbr.org/1981/01/choosing-compatible-acquisitions?registration=success

https://www.cnbc.com/2009/12/29/Top-10-Best-(and-Worst)-Mergers-of-All-Time.html

Professional review by Tracy Farr- Director of Investment Banking at Lazard

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Author Tyler Rowberry

Tyler has lived, traveled, and worked all over the world from Madagascar to Minnesota. He believes those international experiences are what have shaped him to provide unique value wherever he works. His unique value has led him to work on social innovation projects of poverty alleviation in Madagascar to finding new markets to enter for a billion-dollar start-up company. He has found that the most important thing anyone can do in a company is learning fast and always discuss ideas with others. Tyler's core belief is that it is in the pursuit of ideas with others that will help make the world a better place.

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