The mergers and acquisition process can be an integral part of your investment strategy as you look to expand your existing business.
This can be done to realize operational efficiencies and economies of scale, to eliminate competition, move into a niche market or empire building by management, to nail just a few reasons.
Mergers and acquisitions can come in the form of horizontal or vertical mergers.
Let’s take a look at the process of buy a business through mergers and acquisitions.
Types of Mergers and Acquisitions
- Horizontal merger: A horizontal merger occurs when two companies in the same market come together to increase market share and build economies of scale as well as decreasing competition. An ice cream company buys another ice cream company in the same geographic region.
- Vertical merger: A vertical merger is when two companies in the same industry but in different stages of production merge or are acquired. This is ideal for streamlining operations, boosting efficiencies and cutting costs along the supply chain. An ice cream company buys a dairy farm whose milk will be used to make ice cream.
- Conglomerate merger: A conglomerate merger is where two companies in entirely different industries merge. This is often done to diversify so that the larger entity is less beholden to market swings in one particular industry. A brewery purchases an ice company, for example. If the market for ice cream suddenly contracts, the brewery should be largely unaffected.
- Reverse merger: Often referred to as a reverse takeover, a reverse merger is a way for private companies to go public that is simpler and less expensive than an IPO. Investors of a private company acquire the majority of the shares of a public shell company.
- Management buyout: A management buyout is when an individual or group of employees – usually senior members of the management team – purchase the business directly from the owner. They are financed with a mix of personal resources, private equity financiers and seller-financing.
- Leveraged buyout: A leveraged buyout is when one company buys another using a significant amount of borrowed money to fund the acquisition. The assets of the company being purchased is often used as collateral on the loan, along with the assets of the acquiring company.
- Friendly vs. hostile takeover: In a friendly takeover, the target company’s management and board of directors approves the proposal and help to implement it. In a hostile takeover, they do not. In the latter, the acquired must use a tender offer or a proxy fight to complete the takeover.
Preparing for Mergers and Acquisitions
- Identifying the right business to acquire
You’ll want to determine what sort of business you’re looking to acquire and how it fits into your overall acquisition strategy.
If you already operate a successful plumbing business, are you looking to buy another plumbing business to increase market share? Or are you looking to diversify by purchasing an HVAC company?
How does this business fit into your investment thesis? Is it the right size? Is it in the right geographic region?
- Due diligence and valuation
You’ll want to conduct a thorough due diligence process before moving into the negotiation phase.
Check all the public information you can including news stories, websites, along with any public SEC filings.
You’ll also want to get access to three to five years of financial data from the business, including profit and loss statements and balance sheets. This is often done after signing a letter of intent and a non-disclosure agreement.
This is crucial in determining a value for the company you want to buy ahead of the negotiation process. An experience team of professionals can be paramount at this stage.
- Developing a strategy
You should also have a strategy for how the acquisition will fit into your current operation. Are you combining two companies into one? How will they fit together? Where are there efficiencies as well as potential problems?
The Merger and Acquisition Process
The actual merger and acquisition process starts with you making contact with the owner of the potential acquisition expressing your interest in buying the business.
You’ll likely start with a letter of intent (LOI) or teaser and your proposal should be very high level. You’re really just kicking off a conversation.
You’re going to want to conduct a through due diligence search after obtaining detailed financial records and ultimately performing a valuation.
Next you’ll get into the nitty gritty of actually negotiating and agreeing on a price.
Don’t discount the personal at this stage. Lots of small business owners want to see their company in the hands of someone who will maintain their legacy.
Post-Merger or Acquisition Integration
After the deal is closed, it’s time to start integrating the two companies.
This involves work on numerous fronts, from finances and organizational structures to changes in roles and responsibilities and corporate culture.
This is an ongoing process that can take many months if not years to complete. You’ll need to be on hand to monitor this process to make sure you can achieve all the necessary synergies.
It’s important to make changes at a pace that seems reasonable but not one that will ultimately cause too many headaches and actually end up being counterproductive.
Before you start the mergers and acquisitions process, make sure you know exactly what you’re looking for.
Are you looking for a business in the same industry as your current one or in an entirely different market?
Next you’ll want to prepare by identifying those that fit your criteria, completing the due diligence and valuation process before developing your acquisition strategy.
Then you’ll have to negotiate and ultimately close on the deal.
This can help you gain market share or eliminate competition while also maximizing economies of scale.