Mergers and acquisitions

One of the main benefits of mergers or acquisitions is the opportunity for expansion and economies of scale. Improved margins can be achieved through eliminating duplicate facilities, sharing resources such as marketing, or increasing purchasing power to lower costs.

Reasons for growing your business through an acquisition or merger include:

• Reaching new markets. A target business may help you access a wider customer base for your offering and increase your market share. If you are aiming for regional, national or international growth it may be less expensive to buy an existing business than to grow organically.
• Diversifying your offering. There may be scope to use your existing distribution channels to sell other products or services, gained through a merger or acquisition.
• Reducing competition. Buying intellectual property, products or services may be cheaper than developing these yourself and competing with these businesses.
• Improving your capability. Better production or distribution facilities are often less expensive to buy than to build from scratch. Rather than growing a team with specific expertise, you can integrate an established team.

Before pursuing a merger or acquisition you need to establish:

• your opportunity for growth as outlined above, such as geographic expansion, diversification, or improved capabilities, as any merger or acquisition must be consistent with your strategic direction.
• whether you could achieve your goal through organic growth, as this understanding should help you compare the benefits and risks from a merger or acquisition against continuing with your existing structure.
• any relevant external factors such as economic forecasts and political changes and how that might bring new opportunities or risks.

You will need confirmation from your accountants that your business is robust enough to proceed and have an idea of how much finance you can access to conclude a deal.

You should also understand the stages involved in a merger or acquisition, as the extra costs and the level of management time that will be required, will take resources away from the day-to-day running of your business.

Most businesses require a specialist to help refine search criteria and shortlist target businesses. It is strongly recommended that you instruct an adviser with experience in your sector from the outset. Your accountant or solicitor may be able to help you directly, or recommend a suitable individual or firm.

The reason for considering an acquisition or merger will be the starting point for identifying target businesses.

• Grow new markets: you may look at businesses in different regions, or if you want to diversify, you may consider businesses that serve the same area and target audience but with different products.
• Remove competition: you may consider merging with direct competitors to consolidate your market share.
• Improve capability: you may achieve more control over your supply chain if you look at vertical integrations with businesses operating at different levels - such as between a software provider and the platform used to promote it to customers.

When identifying potential targets you will first gather information that is in the public domain for example from websites, social media, Companies House, and press coverage to build a picture of their markets, products and services, head count, and finances.

Opportunities to grow by merger or acquisition may exist where the target business:

• has owners who wish to exit e.g. because they are retiring
• is undervalued
• does not use its assets to maximum effect
• would benefit from relocation
• has poor management
• has complementary products or services which, when combined with yours, will enhance your offering to customers.

Some businesses that are available for acquisition are advertised on the open market. In other cases, deals are done between companies that already have an existing commercial relationship. Sometimes informal and private discussions are the best way to identify targets and assess future appetite for a merger or acquisition.

When you have identified a suitable target business, you will register your interest with the owners or management of that business. Once you agree to move into pre-contract discussions, you may need to sign a non-disclosure agreement so you can access commercially sensitive information to carry out proper assessment and valuation, as well as beginning due diligence, and ensuring all discussions and negotiations remain confidential.

A target business will also be assessing the credibility of your business, and your capability to finance a deal, your future plans and company culture.

Advisers including bankers, accountants, lawyers, and surveyors will be needed at different stages including valuing the business and assets, financing the deal, negotiations, terms and contracts, and reviewing legal elements.

They may charge fees on an hourly, fixed or contingent ‘no deal, no fee’ basis. Before beginning, agree clear terms of reference and how different advisers will co-ordinate.

After you have registered interest in a deal with another business, and confirmed professional advisers, you will probably follow a process that includes due diligence and valuation.

Due diligence

Always involve a lawyer when conducting legal due diligence. Due diligence involves establishing the financial and operational status of the business, uncovering any liabilities including any legal or regulatory issues, and verifying that all information provided by the business is correct.

Directors of companies are answerable to their shareholders for ensuring that this process is properly carried out.

It includes:

• obtaining proof that the target business owns key assets such as property, equipment, intellectual property, copyright, and patents.
• obtaining details of past, current or pending legal cases.
• looking at the detail in the business's current and possible future contractual obligations with its employees (including pension obligations), customers and suppliers.
• considering the impact of a change in the business's ownership on existing contracts.

It will also involve gathering more information on

• the customer base and suppliers
• trends in sales and profit margins
• future forecasts and whether they are realistic
• stock levels, payment terms, and bad debtors
• investments and the business' debts
• systems and processes
• team structures and information about key departments and employees.

Valuation

Buying anything for the best price is a matter of negotiation and obtaining a valuation is the starting point. Even if you are only considering a merger, you should be aware of how much the other business is worth.

However, valuing a business is subjective and brings many challenges as no two businesses are alike and there is significant variation across markets, finances, services, size, history, and potential. There may be heavy reliance on historical data which cannot always be applied to predict future performance.

It’s important to be aware that business valuation is not a regulated profession. You will want to work with a valuer who is:

• a member of a professional body (e.g. accountancy or legal bodies) so is at least bound by professional standards and ethics.
• has experience in your sector and size of business as well as any specific elements of your business, e.g. innovative start-up, family business, intellectual property, etc.
• able to clearly explain their approach, avoiding jargon.

There are many valuation techniques and here are three examples you may come across:

• Asset valuation: This is the value of the business' assets as stated in the audited accounts, minus outstanding liabilities to creditors or tax authorities, bank borrowings and redundancy payments due. It provides a baseline from which to start the valuation process, but might not properly consider intangible assets or growth potential.
• Entry valuation: This compares the cost of acquisition with the cost of starting up a similar business, which might include the assets, product development, employment and marketing costs. Include any savings you can foresee by merging the business with your own.
• Discounted cashflow: This looks at what a forecast cashflow would be worth today, with discounts to cover risks such as unforeseen expenses and can be useful for investors to see the chances of receiving a return on investment over a particular time period.

A business run by one person is generally valued well below the value of a comparable private company run by a larger team of experienced managers. This is partly because customers may be more loyal to the owner-manager and may not remain with any new owner, and a single person is unlikely to have the same breadth of skill set and experience as a team.

The economic cycle affects private business valuations which can vary significantly during a downturn, compared with a boom.

The stages involved when closing a deal include:

• negotiating financing of the acquisition/merger
• making an initial offer subject to contract
• agreeing the main terms of the deal including a payment schedule, warranties and indemnities from the other business
• updating due diligence based on access to the target business
• finalising the terms of the deal - including restructuring of the shareholding, if appropriate
• announcing the deal and communicating it to staff.

In the case of a merger, you will need to negotiate how to integrate key aspects of the two businesses, specifically:

• management
• staff
• technology
• communications
• processes, policies, and procedures
• payroll
• training
• personnel policies
• invoicing and purchasing systems.

When you are considering terms of a potential deal you will probably seek certain confirmations and commitments from the seller of the target business. These will provide a level of assurance and comfort about the deal and are indications of the seller's own confidence in their business.

A written statement from the seller that confirms a key fact about the business is known as a warranty. You may require warranties on the business' assets, the order book, debtors and creditors, employees, legal claims, and the business' audited accounts.

A commitment from the seller to reimburse you in full in certain situations is known as an indemnity. You might seek indemnities for unreported tax liabilities, for example.

Your professional adviser can assist in reviewing the content and adequacy of warranties and indemnities.

The extent and quality of the planning and research you do before a merger or acquisition deal will largely determine the outcome. However, sometimes situations outside your control will arise and you may find it useful to consider and prepare for these risks.

• An acquisition could become expensive if you end up in a bidding war where other parties are equally determined to buy the target business.
• A merger could become expensive if you cannot agree terms such as who will run the combined business or how long the other owner will remain involved in the business.
• Both mergers and acquisitions can damage your own business performance because of time spent on the deal and a mood of uncertainty.

You may also face pitfalls following a deal such as:

• the target business does not do as well as expected
• the costs you expected to save do not materialise
• key people leave
• incompatible business cultures
• resources being diverted from your business's main aims.

Get expert advice from professionals, such as management accountants and solicitors, with experience in similar deals to help forecast potential pitfalls and to address any that arise.

Mergers and acquisitions will have a big impact on the staff working in both companies.

Challenges arising from merger and acquisition deals

People are at the centre of any business, and mergers and acquisitions create specific challenges:

• A key motivation for a deal may be accessing an established team of capable staff and retention of those staff will be critical to success.
• Another attraction of a merger or acquisition may be increased efficiency, resulting in some team restructures or cuts.
• Non-disclosure agreements may significantly restrict your ability to share information with staff or even disclose that a deal is in progress.
• Some staff may need to take on more responsibilities while you negotiate the deal, which can be an opportunity but also a burden for them, especially if they don’t know why.
• Whether another business has a completely compatible culture with yours is very hard to establish until a deal is complete.

Staff issues often play a significant part in whether a merger or acquisition succeeds or fails. You will need to consider potential impacts on staff such as:

• skills gaps and how to fill them
• which posts will be filled by staff either from your business or the target business
• pay differentials between the two companies
• how staff from both businesses can build working relationships
• how to share knowledge between staff
• appropriate policies and procedures for the combined business
• relocation issues
• trade union matters

A merger or acquisition will often go more smoothly if the staff in your business and the target business are protected from uncertainty and involved in the process at the appropriate point.

Before the deal begins, consider how you can:

• keep key staff informed - bear in mind that some information may need to remain confidential
• retain key staff - e.g. through bonuses or other incentives
• involve key staff in the due diligence

Consulting staff

The Information and Consultation of Employees (ICE) Regulations may require you to inform and consult employees on certain aspects of the merger. If you have 50 or more employees you are obliged to agree a procedure for informing and consulting employees if more than 10% of employees request a system.

Where an employer has a pre-existing procedure for informing staff and fails to consult, employees can complain to the Central Arbitration Committee, who may impose significant fines.

Your professional adviser should be able to guide you as to who needs to know what.

After the deal you may find it useful to see staff individually or in small groups to explain future plans and to answer questions.

It is important to get expert advice to help with staff issues such as new employee terms (including pension provision), changes in employment contracts, and your responsibilities to employee rights after a merger or acquisition.