Classification of M&A activity based on the operational objectives:
In the business world, it is said that one requires everything to grow and absence of only one thing is sufficient to hold you down or fail. Many companies have many advantages, capabilities, cash, good management, etc but they lack one or the other critical resource that they cannot develop in-house or purchase in the open market. This precious resource, however, may be easily available with a small time company around them. It is in benefit of both of these parties to associate together and complement each other’s strengths.
Following are the objectives on operational front of the companies why they come together:
Human resources:
Recruitment of high quality talent pool:
This is called acquihiring in merger acquisition world. A large company acquires a smaller company basically to to hire its trained talent pool or manpower strength rather than recruiting people from the employment market.
Marketing:
Entry into new product segments:
Many a time, a company wants to enter a certain range of products but it doesn’t have a starting point to manufacture the product or to enter a market. Acquiring a company in that product line gives the acquirer insight into the business and avoid all the the errors in the beginning of entry into new product.
Market segment access:
When two companies combine, they get access to each others clients, markets, advertising channels, promotion strategies, marketing agencies, distribution channel, etc. This reduces the cost of marketing and also cost of the sales process. This may help in increasing the sales volume. This may help in selling additional products. This may help in using the companies’ distribution channels to take the products to more customers. This may reduce the advertising budget.
New geographical markets:
A company might be doing excellent in its own geographical area but it may not be getting good opportunity in a neighbouring area or an excellent market located somewhere else because of the lead time required to get established in any new market. Tp tap such attractive markets it makes all the sense to get associated through mergers and acquisitions with the existing players in those markets.
Market share:
When two companies combine, in the market share of the merged entity becomes much higher. Hence, the importance of the company in determination of the prices, margins, supply chain parameter, imports, exports,
service quality, visibility takes altogether new dimension.
Eligibility for participation in the large tenders:
Most of the public sector and private sector tenders have stringent eligibility norms to put a price bid. Many small and medium enterprises do not grow because they cannot participate in the tenders. A small company cannot meet eligibility criteria in terms of the number of projects, size of projects, value of projects, the complexity of the project, etc and cannot participate in the tender. The authorities generally require that the bidder has at least one experience in the specific niche activity expected in the project. The companies cannot meet all these conditions nor they can bargain for lowering these criteria in the pre-bid meetings. However, when the companies get combined, their operational credentials and financial net worth increases and they can participate in the large tenders which they individually could not.
Sharing of marketing infrastructure:
For many companies, production, financing, technology, manpower, me not be a problem. For them, the problem is competition by advertising. The sale might be directly proportional to the recall of the brand in the mind of the general buyer. The moment you reduce the advertising spend, sale starts to go down. In this types of circumstances, the advertising expenses may form as good as 25 to 30% of the total cost. If the company join hands through mergers and acquisitions, they save the cost on redundant marketing infrastructure.
Reduction in competition:
If the two competing companies are combined through mergers and acquisitions, from the perspective of the companies, the market share increases, and the probability of failure due to excessive competition reduces. The companies have to obtain approval from the Competition Commission of India if they are large scale players before the merger.
Association with the famous brand:
While some companies might have modern technology, modern processes, very high quality product, very high margin of profit but they might be very new in the market and the customers maybe hesitant in buying their products. There advertising may not go in the right direction. Or they may be unsatisfied with the pace of growth. In such circumstances they are supposed to acquire or get merged with a well-established, famous, repeated brand with very large goodwill in the general society.
Operations management:
Increase in scale of operation:
There are two fold advantages on the scale front of a merger. First that the company can manufacture the goods on a larger scale. The second benefit is that it reduces cost per item of production due to economies of scale.
Acquisition of unique operational capabilities:
The products and services a company produces show the operational capability that is being used. Given a chance, the same set of people and machines can also produce new products, may be more valuable. These are called operational capabilities of an organisation. When companies combine through mergers and acquisitions, they acquire manufacturing and operational capabilities of each other.
Business expansion through new projects:
Getting merged with the cash rich company helps a business to marry its business plans with the the capital rich people. This can be achieved through issue of additional equity.
Bulk buying discount in procurement:
When two companies combine the volume of purchase increases and the new resultant company can bargain for bulk buying discounts, more credit period, better terms of supply, etc which is otherwise not possible when the requirement is on small scale.
Intellectual property for premium production:
Getting ownership of the intellectual property of a company can be one of the great objectives of a merger and acquisition activity. Patents, trademarks, copyrights, industrial designs, geographical indicators have very long protected life. Their use might not be permitted for the outsiders, or may be permitted under hectic royalty, or may be permitted under very strict conditions. Companies may acquire other companies for the value or the potential of their patents, brands, stage of advancement of the research and development efforts, etc.
Access to hi-tech research and development (R&D):
If a company acquires a company having reached advanced stage of research and development attempts, it can tap the fruits of such successful research. The company with ability to do successful research and company that can finance costly research initiatives and can bring the developed the product to the market, can benefit by association through mergers and acquisitions.
Financial management:
Working capital:
In many businesses working capital forms a large chunk of initial funds required. Apohan has observed in its market survey that many small and medium enterprises of the first generation businessman are not aware of the concept of working capital. Rather, they are not aware of the seriousness the concept of working capital provisioning. Small and medium enterprises live under the misconception that working capital is a short-term finance and it is at a constant level for every year. They also use 100% CC and OD limits with the bank which should be actually reserved for seasonal fluctuations and occasional credit crunch. SMEs run a business with the lower working capital at operating capacities much below the break even capacity and are not able to meet all the liabilities of the business.
A break-even operating capacity is the capacity at which a business generates sufficient cash to exhaustively meet its all operational, financial and any other kind of liabilities. Operating the plant below break even capacity leads to liquidation of the company in the long-term. A company always must operate much beyond its break even working capital city. But, this requires ample amount of working capital. Companies requiring very high level of working capital can finance the same through equity funding through mergers and acquisitions.Saving of overhead expenses:
Overhead means input of the manufacturing process which cannot be attributed or allocated to a specific output item. For example, if you are manufacturing pillows, you can calculate how much cloth per pillow directly, but the rent of the manufacturing plant cannot be calculated so directly. There are two types of overheads- Manufacturing overheads (such as rent of manufacturing facility, utility bills) and corporate overheads (salaries of top management, head office expenses, consulting charges). Merger of two companies results in saving corporate overheads as now there is only one management, one head office for the new setup. A lot of redundant managerial posts can also be done away with. The cost of company secretaries, chartered accountants and other consultants also can be saved.
Credit rating:
If one of the merging companies has a good credit rating, it can implement the same financial strategy for the merged entity and the credit rating benefits can be availed on a larger scale. More amount of money can be borrowed from the banks, NBFCs, institutional lenders, through bonds and also on better terms at cheaper rates.
Tax saving:
In a merger, when the the accounting statements of two companies are consolidated, and if one of the companies has accumulated losses then the merger results in saving of tax for the acquiring company. It is also possible, that the various types of input credits or indirect taxes can now be quickly used in the new merged company. Depending upon which legal entity remains, its tax incentives may now be available for the entire setup. Also, there is saving on tax compliance fees.
Benefits from government schemes:
If one of the company is availing a certain scheme or exemption from a certain tax, or from certain charges in the utility bills. It main benefit from a government grant, or occasional government support, government preference in procurement, etc.
Becoming a listed company:
When up private limited company acquires or gets acquired by a public limited company, then the company automatically becomes a listed company. Thus, the company achieves the objective of going public without the painful process of initial public offer. There are two main advantages of going public: The amount of capital available with the general public can be treated as good as infinite for all practical purposes; the cost of capital from the perspective of the incumbent investors can be treated as good as the lowest among all investor classes as the public is is ready to pay a very heavy premium depending upon real perspective of the potential of the company.
Financial turnaround:
As we discussed, turnaround from a the bad financial situation can be one of the objectives of mergers and acquisitions. Many a time, a company has very good product, very good technology, very good knowledge of manufacturing process, very good knowledge of management of operations, very good client network, a decent margin on sales, very good ideas of new projects, very good ideas of new products, very good human resources, but they just don’t have knowledge of financing the company properly. Some unfortunate external events, aur an occasional internal error, or due to lack of business judgement, these companies having poor understanding of finance become loss making and start moving in the direction of liquidation. Timely acquisition of full or partial control of these companies through infusion of equity funding through issue of additional shares not only turns around it financially but also takes care of the financial management aspect in future.
Strategic management:
Synergies in operations, technology, marketing and corporate matters:
Having two setups means duplicity of expenses, duplicity of efforts, duplicity of of compliances, duplicity of overheads. It also means excessive supply in the market with a negative impact on prices of the products the companies selling. When two companies combine, the wastage on these redundant expenses it stopped and the negative impact on the prices in the market is also stopped. The wealth or valuation of the merged entity far exceeds the addition of the wealth of the two companies before merger. This is called synergy.
Diversification for risk mitigation:
If a company acquires another company in a different business, then the impact of business cycles or unfortunate events cannot destabilise the company. If one business is not doing good, the other will keep everything afloat. This is called diversification and it reduces the long-term risk of a business.
Transformation into a professional company:
After a merger, measures are undertaken for the transformation of the target company. Associated with the company that has very high standards of corporate governance, very high calibre of management, higher degree of compliance, higher visibility in the market results, a very high brand reputation in transformation of the merged company. A set of good company policies governing the processes of all the departments, access to professional business software, standard operating processes, compliance of technical standards for products and manufacturing processes, compliance of quality standard certifications, all the licences, permits, approvals from all relevant government bodies, etc result in transformation of the acquired company as well. This acquired entity starts functioning in the manner of the acquirer an address a lot of value.
Apohan very well understands all the benefits of the activities of strategic nature such as mergers and acquisitions. Apohan carries out professional, end-to-end, customized consultancy services by understanding the operational objectives of a business. Apohan carries out all types of equity transactions, right from the problem identification phase, to the closure of deal with perfection.