Although they’re sometimes used almost interchangeably, a merger is distinctly different from an acquisition. While an acquisition involves one company taking over another and usually amalgamating it, a merger involves two companies coming together and creating a new entity, ideally composed of the best elements of each of the individual companies.
Needless to say, none of this happens on its own. Both before the transaction and after, a number of steps need to be taken to ensure that a merger is a success. The following steps, which take the perspective of just one company in the merger, should thus be considered a general guide to merging two companies. And what is more important, they should be performed to order to avoid common M&A challenges.
Establishing the motive
In much the same way as an acquisition, it’s important to establish a good motive for a merger. Without one, the merger is destined to fail from the outset. A big distinction between a merger and an acquisition is that the motive has to be strong enough to convince the other party to the deal that the merger is a good idea.
In a way, this is a useful security mechanism of mergers that doesn’t exist in acquisitions: If you overbid for a target company, the counterparty will be quite happy to tell you that you’re doing the right thing. On the other hand, if you approach a company about a merger and your motive is weak, they probably won’t be slow in telling you, potentially saving you from a value destroying deal.
While the motive for an acquisition can be financial or strategic, for a merger, it’s invariably strategic; there should be something that both companies can achieve together that they can’t achieve separately. Or, they should have significantly more potential together than they have apart. Examples of this might include but not be limited to:
- Complementary product or service lines
- Complementary regional presence (joining to create a national player)
- Ability to create economies of scale/scope
- Complementary operations - e.g. specialisms in different niches
If you approach a company in your industry with a pitch about a merger, it’s likely to involve at least one of these elements. Assuming that the other company is performing well - e.g.. it’s not in financial difficulty or experiencing a long-term deterioration in sales - and your pitch grabs their interest, you may have the basis for a strong motive for a merger.
Understand what the merged entity will look like
All too often, two companies merge thinking that they’ll automatically become more than the sum of the individual parts. If anything, a merger is even more difficult to pull off than an acquisition as it usually involves a merger of (near) equals, while an acquisition, particularly a bolt-on acquisition, may be a larger company acquiring a much smaller one.
Having agreed to the principle of a merger, the two sides need to get into the gritty details about what the newly merged company will look like:
- Who’s the CEO?
- Who’s on the board?
- Where is the new headquarters?
- What will the new company be called?
And these are just to address some of the high level issues.
The real complications arise when the two companies start to talk about company culture, the new company’s strategic direction and the long-term ambitions of the company:
- How much of the company’s money is reinvested every year?
- Are you both happy to load up on debt to fund your ambitions, or is one side more risk averse than the other?
Unsurprisingly, a deal is more likely to fall through here than at any other stage of the process. The idea of taking the best components from each company and bringing them to the new entity is all very well, but that means that both companies have to admit that the other’s way of doing things is better in some instances - and that can be extremely difficult for some people.
But what should emerge from these efforts is a high-level strategic plan of what the new company will look like, combined with a better understanding of who you’re getting into the business with. If the process has run smoothly until this point, there’s every reason to believe that the merger will indeed be a case of 1+1=3.
Structuring a Deal
Assuming you’ve arrived at a high level plan for the combined entity, there’ll usually have been some discussion - not necessarily detailed - about the structure of a deal. Mergers usually involve a much larger portion of equity than an acquisition. That’s good from the sense of requiring less cash. On the flip side, it means relinquishing some of the control.
Establishing exactly how much value each party brings to the new company is the function, as always, of due diligence. Just as with acquisitions, due diligence is a key success factor for mergers. But now, it’s not just a buyer evaluating a target company - it’s both companies evaluating each other. In theory, this should lead a more cooperative due diligence process.
Usually, a new legal entity is formed and both companies share its equity in pre-agreed amounts. One of the companies entering the merger may also pay cash to the other in an effort to retain more control. This is where the difference between mergers and acquisitions tends to blur, but the creation of a new legal entity is distinct to mergers.
Post-transaction, a merger may look a lot like an acquisition. If both sides are already in broad agreement about what the new entity should look like, now is the time to start taking steps to make the plans a reality. This will almost certainly involve compromises on the part of both companies, unlike an acquisition, where adaptation is required only on the part of the target company.
Both companies will undergo changes here which underlines the importance of implementing a change management program. In a previous article, we outlined the benefits of hiring a change manager in the M&A process. Their input is arguably even more fundamental to the success of a merger than it is to an acquisition.
The literature on mergers and acquisitions often overlooks the features which are specific to mergers. This is an unwise oversight. Mergers offer a way for companies which aren’t cash rich to join with other companies and create entities which automatically have far more potential. And that should ultimately be the goal of any M&A-based transaction.