Determining the best course of action for growing a business is a challenge many corporate finance professionals must face. Is it better to develop organically by investing in projects within the company or expand by acquiring other firms?
The latter option—inorganic growth—is achieved through mergers and acquisitions. It’s also one that many firms are currently pursuing.
According to a survey by Deloitte, 92 percent of executives at U.S. corporations and private equity firms expect merger and acquisition deal volume to increase or stay the same over the next 12 months.
Despite this optimism, these deals can be fraught with complications. Before examining these transactions’ potential risks, it’s important to understand what mergers and acquisitions are and how they differ.
What Are Mergers and Acquisitions?
Mergers and acquisitions (M&A) refer to the process of consolidating companies or their assets. The terms “merger” and “acquisition” are often used interchangeably but have different meanings.
What Is a Merger?
A merger occurs when two companies agree to consolidate into a new entity. For instance, Company A and Company B join to create a new entity, Company C.
One example is the 1999 merger of Exxon Corporation and Mobil Corporation. These two leading oil production companies created a joint entity, Exxon Mobil Corporation.
What Is an Acquisition?
An acquisition is a process whereby an existing company purchases and assumes ownership over another firm or asset. For instance, Company A acquires Company B, and the two companies continue to operate as an existing entity, Company A.
A well-known example is e-commerce giant Amazon’s purchase of Whole Foods for $13.7 billion in 2017. As a result of the acquisition, Amazon now holds ownership of Whole Foods and its assets. A more recent example took place in February 2022 when Frontier Airlines acquired Spirit Airlines for $6.6 billion.
Both types of M&A transactions can enable organizations to expand their reach and increase market share.
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Mergers and acquisitions happen frequently. According to the Institute of Mergers, Acquisitions, and Alliances (IMAA), there’ve been nearly 800,000 such transactions worldwide, worth an estimated $57 trillion.
Some other well-known examples of mergers and acquisitions include:
- The Walt Disney Company’s acquisitions of several companies, including Miramax Films (1993), Fox Family Worldwide (2001), The Muppets (2004), Pixar (2006), Marvel (2009), Lucasfilm (2012), and 21st Century Fox (2019)
- Google’s acquisitions of YouTube (2006), DoubleClick (2007), and Waze (2013)
- The 2018-19 merger between CVS and Aetna
- The 2015 merger between Kraft FoodsGroup Inc. and the H.J. Heinz Company
Risks of Mergers and Acquisitions
While mergers and acquisitions can lead to tremendous growth opportunities, they can also come with substantial drawbacks—such as integration risks. Here’s a look at four risk factors associated with M&A deals and when they can arise.
Before the Merger or Acquisition
1. Lack of Due Diligence
Due diligence is critical to preparing for M&A transactions. When purchasing preexisting assets, it’s the seller who holds much of the information. Prior to the transaction, your company should learn as much as possible about the selling firm’s financials, contracts, customers, insurance, and other pertinent information to ensure it has an in-depth understanding of the deal on the table.
Without a thorough information-seeking process, your firm could get caught up in obligations it’s not yet ready to assume, such as litigation issues and complicated tax matters.
2. Overpayment
Overpayment is a common pitfall of mergers and acquisitions. There can be a lot of pressure from several sides when preparing for such significant transactions. In addition to the seller, you may be urged by intermediaries involved in the agreement, along with teams within your own company. This could force your organization to overpay to simply push the deal through, rather than work out an arrangement that creates value while avoiding additional costs.
After the Merger or Acquisition
3. Miscalculating Synergies
Several problems can arise if your organization completes a transaction with misguided notions about realizing synergies, or ways in which the two companies combined are more valuable than they are individually.
Firms often enter a deal overly optimistic about the impending payoff and underestimate how long synergies take to come to fruition. Consolidating workforces and operational processes takes time. Excess costs can also be accrued if there are unrealistic expectations around when the integration will be complete.
Synergy miscalculations can also feed overpayment, as they may be rolled into the purchase price so your company gains control over assets before fully reaping benefits from them.
4. Integration Issues
Significant integration issues can crop up after a merger or acquisition—both operationally and culturally. A merger or acquisition is a major organizational change with the potential to alter the processes underlying how both businesses operate.
If a detailed integration plan isn’t in place when a transaction is made, the companies involved may function separately for longer than anticipated, resulting in increased costs.
Differences in company culture may also pose a challenge. According to research by McKinsey, approximately 95 percent of executives say cultural fit is vital to an integration’s success.
While one company may be more entrepreneurial and innovation-focused, the other may be more traditional and results-driven. If a transaction involves acquiring an international business, employees may suddenly find themselves coordinating with or managing a global team.
Without a robust integration strategy that takes each organization’s values, norms, and assumptions into account, collaboration issues may arise that impede efficiency and delay the consolidation process.
How to Mitigate Risks in Mergers and Acquisitions
Mergers and acquisitions can be a boon to corporate growth. A common issue underlying many of the risks that come with negotiating M&A deals is the tendency to involve finance too late in the process.
The finance department is often perceived as the gatekeeper for capital allocation, and many business professionals tend to hold off on its involvement for fear of halting proceedings. The earlier you consider financial implications, the better equipped you’ll be to avoid the common pitfalls of mergers and acquisitions.
With knowledge of finance and risk assessment, you can help your company navigate these complex transactions and increase its market share.
Do you want to develop a toolkit for making smarter financial decisions? Explore Leading with Finance—one of our online finance and accounting courses—and discover how you can identify ways to create and measure value in your organization.
This post was updated on July 28, 2022. It was originally published on July 25, 2019.
