The Basics of the Merger and Acquisition Process

Any industry can face challenges to growth and longevity because of advances in technology, changing consumer preferences or competitive pressure to control costs and increase profits. In many cases, acquiring or merging with another company may be the most efficient way to increase distribution reach, enter a new market or add new products.

The terms merger and acquisition are often referred to together as M&A or used interchangeably, but they carry distinct meanings. An acquisition can be the purchase of an asset, such as a factory, technology, an operating division or an entire company—and the buyer generally takes the majority stake in that company. Mergers happen when the companies are combined to make a new company or when one company becomes part of another and ceases to exist.

Finding the optimal strategy for growth

Companies decide to initiate mergers or acquisitions for a variety of reasons. Overall, it's about achieving the best fit for the business strategy. In some cases, the financing terms could be more amenable than those required to finance organic internal growth. Or perhaps internal growth could take too much time or result in lower valuations.

The merger and acquisition process typically requires a significant amount of time and company resources. The decision to target and purchase another company should be strategically planned, and elements like the internal capabilities of your business and competition in the industry should be weighed carefully.

Key M&A stages

Many firms and banks agree on five stages in the M&A process. On average, these steps take more than 2 years to complete.

• Preparation and planning: In this stage, the company assembles a team, finalizes the M&A plan, finds potential target companies and initiates preliminary due diligence on the final M&A target.
• Negotiations: Next, the two companies negotiate deal terms, consider regulatory implications and consider other laws and regulations.
• Due diligence: At this point, the company establishes a due diligence team that analyzes the target business and reviews the data.
• Deal closing: To complete the deal, the companies finish the closing procedures, finalize the purchase and sale agreement and arrange payment. Then, the buyer takes control.
• Post-merger integration: The final stage of M&A is post-merger integration. The company outlines ways to achieve merger benefits, develops a timeline with milestones and integrates the target company.

Pricing and value

Mergers and acquisitions can hinge on the pricing and value of the target asset. If a target company's shares are publicly traded on a stock exchange, the process can essentially involve multiplying the company's stock price by its outstanding shares. Pricing and valuing privately held companies can be more challenging. Because their shares aren't publicly traded, several factors can impact the outcome of the offer price negotiations, including:

• Whether the deal is a strategic acquisition or merger versus a private equity purchase
• Deal financing options available
• Licensed intellectual property involved
• Valuations used in the most recent financing rounds
• Financial projections and historical performances
• The valuations of comparable firms—multiples of revenue versus multiples of EBITDA
• Recent sales prices of shares

The presence of multiple interested parties, as well as industry structural shifts, can also affect pricing.

Whether to work with an advisor—or two

An analysis by Harvard Business Review found that companies who worked with one advisor during a merger or acquisition outperformed those that worked without one. However, the analysis also showed that companies who worked with two advisors performed worse than companies who worked with none, and each additional advisor led to even worse stock market reactions. So does that mean you should always retain just one advisor?

In some cases, multiple advisors may be necessary. Deals that are highly complex or that include multiple stakeholders who all need representation may require more advisors. These additional advisors may slow down decision-making, lead to more leaks, force compromise and cause unnecessary competition.

To effectively navigate these challenges, good executive management is key. Choose advisors who can work well together as a team—advisors you've worked well with in the past are often the best resources—and clearly define their responsibilities. Curb opportunistic behavior by paying advisors regardless of the outcome. Make sure to involve senior leaders from the start and gather feedback during the process to inform future decision-making. It's not impossible to build a good team of M&A advisors—and it may be necessary for success.

Risk management and due diligence

As deals are typically financed by stocks and loans, consider how economic conditions can impact the transaction and long-term success. Interest rates and financial market events can alter the dynamics. An economic slowdown can be an opportune time to get a bargain on the price of a company that's becoming illiquid. However, it's also essential to carefully review the cash flow and expenses of that company and evaluate the benefits of the acquisition at a moment of economic uncertainty.

Even with the best merger and acquisitions deals, issues can arise at any point. Sometimes, a problematic deal goes through, but with a reduction in shareholder value. Be prepared to manage risks both pre- and post-transaction.

Your due diligence should involve a thorough examination of not only contracts and other corporate documents but also the corporate history, mission, values, culture and intangible assets. Careful review of these factors may help prevent roadblocks—and uncover new opportunities to realize added value from the merger or acquisition.