A successful M&A: A matter of art, accounting
March 30, 2015
Merger-and-acquisition activity in the United States last year totaled $1.6 trillion, the highest level on record, according to Dealogic.
The New York-based analysis firm mostly tracks big-company transactions. Still, there's little doubt that the combination of continued low interest rates, a stronger economy and growing stocks of cash on corporate balance sheets is generating plenty of interest in mergers and acquisition among small and mid-sized companies as well.
While lots of old-fashioned number-crunching will precede even the simplest, most straightforward transaction, a successful merger or acquisition is a matter of art as much as it's a matter of accounting science.
No matter whether you're an executive looking to restructure your company or an investor sorting through the possibilities in the latest corporate announcement, it's generally a good practice to think through the motives behind the transaction. Some acquisitions are driven by the belief that the target company is undervalued and presents an opportunity for growth. Sometimes a smaller company will develop a technology that draws the interest of buyers. Other executives hope that mergers will provide diversification or cost-savings synergies. And, while few say it aloud, some executives are spurred by hubris or managerial self-interest to chase an acquisition.
At the same time, some executives decide to shed money-losing divisions or to split their organizations into two or more stand-alone companies in the hope that each will do better on its own.
Restructuring always is a complicated process, and the challenges that face the owner of a small or mid-sized company are the same as those encountered by the top executives of a multinational corporation. In fact, owners and managers of companies large and small can learn much by watching how others handle restructurings.
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While transactions often are perceived as entirely numbers-driven, the most important questions center on culture issues. Companies have distinct personalities and unique cultures; the combination of two organizations with different structures and operating philosophies can be very difficult. A business combination might make total sense on paper, but conflicts in cultural issues and operating procedures may flash a red warning light.
Successful combinations require, first and foremost, that owners and managers understand the culture of their own companies. That requires some honest self-appraisal. The poster in the company's lobby spells out its mission statement, but the day-to-day philosophy in the offices and on the shop floor may be entirely different.
Straightforward conversation with executives of the other company involved in the transaction reduces the likelihood that culture clashes will come as a surprise. Some conflicts among corporate cultures probably are inevitable. Savvy executives want to know what problems they can expect so they can make plans to resolve them.
Culture is important, too, in divestitures. Sometimes a newly divested division unit discovers wellsprings of innovation, creativity and nimbleness when it's cut loose to stand on its own.
Before they get too far along, acquiring executives need to ask themselves a seemingly simple, but often difficult question: What are you buying? Are you acquiring market share? Infrastructure? Talent? Product development?
Further, you need to understand the competitive advantage you expect from the acquisition. Often, these transactions make the most sense if you're acquiring a technology or a market that would be difficult to create yourself. It often makes sense, too, to use an acquisition to open a geographic market in which you have little presence or to gain talent and technology that would take too long to develop.
Ask yourself at every turn: Does it make more sense to buy this than to build it ourselves? And does the price justify that decision?
Which bring us to the question — What's the price? — that's often the headline news for buyers and sellers alike.
Valuation never is as simple as adding up assets, subtracting liabilities and negotiating a fair price for the equity. Many buyers are willing to pay a premium if they envision synergies that will make the merged operations more efficient and more profitable. But what's the hard-and-fast value of synergy? How much should a buyer be willing to pay for diversification?
The challenges of valuation become even more difficult with early-stage companies, whose value is often reflected in their potential rather than today's realities. Should a buyer pay only for their current value? What is the value of potential future growth? Or should the deal reflect a combination of current value and future potential? When Facebook paid $19 billion for WhatsApp in 2014, jaws dropped. But Facebook was willing to pay big for the large-scale network of users attracted by WhatsApp, particularly in Europe, India and Latin America.
Still, mergers of companies that are at different stages of development require complex analysis of value. Pay particular attention to the value of stock rather than cash used in the transaction. Undervalued stock or equity could prove more valuable than cash, while inflated stock or equity could prove to be less valuable than cash.
Finally, careful analysis of the tax implications of the transaction, and structuring the process correctly to take advantage of tax laws, can directly affect the financial results for both parties.
While transactions that are largely driven by tax considerations are relatively rare — despite the spate of U.S. companies that merged with offshore partners to reduce their payments to the IRS — every restructuring presents complex tax questions.
Among the issues that must be addressed are the financial structure and legal status of the deal, the potential for capital gains as opposed to ordinary income in the sales proceeds, the accrued liabilities of the target company, and the transaction costs.
The structure of any corporate merger or business combination needs to be thoroughly analyzed by an accountant before a transaction is finalized. Failure to get good advice could be expensive or even kill the deal.
John Solari is the managing partner of J.A. Solari & Partners. He has 25 years of accounting experience and is also a member of the American Institute of Certified Public Accountants and the Nevada Society of Certified Public Accountants.