Grow Fast or Die Slow: Why are M&As an important growth strategy for companies?
After years of strong growth and increased market share, many companies eventually stagnate and are unable to sustain the growth that made them successful.
The revenue figure varies, depending on the market and industry, but the symptom is universal: year-over-year growth gets boring. Changes in the business that once delivered significant upside now barely move the needle. The core business has grown to a size where only significant and unnatural changes will have the potential to produce the growth that has been achieved in the past. These “unnatural” changes could be what are described as inorganic growth strategies or commonly known as “Mergers and Acquisitions”. These strategies, when planned and executed correctly, can help companies grow and increase business value, ultimately creating an organization positioned for strong compound growth.
Companies can pursue inorganic growth in a variety of ways, from win-win strategic relationships to traditional mergers and acquisitions (M&As).
Many companies have used strategic partnerships as a method to leverage their business. These partnerships allow complementary organizations to generate mutually beneficial revenue synergies and cost savings.
In some cases, this is a great way for a potential acquirer to better understand the partner’s business. In the software technology industry, many of these strategic relationships create channels to new markets.
Growth through mergers and acquisitions
Mergers and acquisitions offer a means to expand into new markets and/or improve purchasing power. In addition to acquiring new customers, talent, intellectual property, and the ideas that come with them, purchasing from another company can streamline the supply chain by eliminating pass-through fees or improving efficiencies and economies of scale.
Mergers and acquisitions can also increase the metrics on which the organization’s valuation is based. For example, a $100 million revenue company that has similar margins as its $500 million public competitor will be valued at a lower multiple of earnings or revenue. As that $100 million company grows through mergers and acquisitions, its multiple value will increase and surpass its competitor’s based on their respective growth rates. Through the ability to sell each company’s products and services to the other’s customer base, the combined company has the ability to increase revenue and reduce costs much better than if they stood alone.
Mergers and acquisitions may also be the strategy in markets where scale and market coverage drive revenue.
Considerations during mergers and acquisitions
While the rewards of inorganic growth can be great, so are the potential pitfalls that need to be considered. Developing a strong execution strategy requires an objective look at the organization’s current strengths and weaknesses, along with a clear understanding of all the risks associated with trying to grow through mergers and acquisitions.
- Loss of Concentration: Whether buying or selling, the trading process carries emotional and financial risks.
Both parties often become emotionally invested in the deal, which can make it difficult to objectively review all the elements and make the decision to back off if necessary. In addition, negotiations and the Due Diligence process can distract attention from the fundamental day-to-day of companies. For a successful M&A to occur, companies must continue to function throughout the entire transaction.
Not only can a company’s value fall and jeopardize the deal, but failed negotiations can also leave both merger candidates in worse shape than when they started.
- Transactional Risk: As much as a deal may seem “perfect” at first, nothing is easy and definitely not guaranteed when progressing through all the required elements of a deal.
Organizations must navigate many obstacles to a successful outcome, including detailed terms of the deal, due diligence, legal and regulatory issues, staff retention, integration and upgrades, and of course, funding.
Some of these factors are beyond the control of the key players and defining these issues early on is very important. Setting goals and objectives with possible exit ramps to finish the deal will help ensure progress toward a successful outcome, or reduce time and money spent on a failed deal.
- Due Diligence Risk: Due diligence during an M&A process can also lead to major unintended consequences. The dangers are especially high in companies with significant intellectual property value.
There are numerous examples where a company expressed interest in buying a smaller company and agreed to an NDA as part of the initial due diligence process. After completing due diligence, the potential acquirer passed the acquisition only later to launch a product based on technology that was reviewed under the NDA.
To protect intellectual property, a potential acquisition target must not allow a potential buyer access to trade secrets of current or future products or services. It is wise for both parties to use an outside firm to review these materials to avoid any future litigation.
- Cultural Risk: The blending of cultures is critical to a successful merger or acquisition, and a task that becomes more difficult as time goes on.
An organization that values flexible hours and quality of life, for example, may lose key personnel after merging with a company where employees are required to be present in the office.
Trying to force two disparate cultures will likely end up with some of the most valuable talent finding new employers.
- Business Complexity: The more complex the business operation, the more difficult it will be to introduce changes. Organizations need to analyze the complexity of their systems, as well as the feasibility of integrating new concepts or businesses.
Rather than attempt to merge complicated operations, maintaining separate entities with separate leadership may be optimal in some situations.
Reaching the next level
When an organization stagnates in its financial performance, inorganic growth strategies can bring new efficiencies and opportunities, but come with important considerations.
Fiduvalor, financial solutions, has extensive experience in providing strategic advice on the elements of inorganic growth strategies.
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