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5 Advantages & Disadvantages of M&A as a Growth Strategy

Kison Patel
CEO and Founder of DealRoom
Kison Patel

Kison Patel is the Founder and CEO of DealRoom, a Chicago-based diligence management software that uses Agile principles to innovate and modernize the finance industry. As a former M&A advisor with over a decade of experience, Kison developed DealRoom after seeing first hand a number of deep-seated, industry-wide structural issues and inefficiencies.

CEO and Founder of DealRoom

Mergers and acquisitions are a popular growth strategy for companies hoping to expand into new markets, rise above competition or acquire new skill sets in their industries.

The rapidly changing economy fuelled by technological advancements calls for companies to rapidly enhance the scale of their operations, which can only be made possible through mergers.

Mergers are essentially done for two reasons and those are either monetary or strategic. While monetary mergers are pursued for the sake of investment, strategic mergers are the real deal and are pursued to solve your company’s problems.

Whether your company may be in need to acquire a certain factory or exclusive partnership, venture into a new product line, or enter a new market.

We at DealRoom help dozens of companies organize their M&A process and below, we look at the advantages and disadvantages of using M&A for your company’s growth strategy. We begin with the advantages.

Advantages of M&A as Business Growth Strategy

  • Allow to Increase Service Offering
  • Allow to Acquire Intellectual Property
  • Gain Operational Synergies
  • Help Diversify Investments
  • Make R&D More Efficient

1. Increase Service Offering

Changing laws and regulations can often create gaps in your company’s service offerings. Even if the gaps aren’t brought about by a change in laws, it could simply be a pre-existing gap that you never thought to fill.

Filling in such gaps can be accomplished by a strategic merger. 

For instance, a construction company in Texas may look to merge with or acquire an order supply fulfillment firm in California to expand its service offering. Not only would this create more construction jobs texas, but it would also lead to pertaining growth in California too.

2. Acquire Intellectual Property

Many giants in most industries have the funds and expertise to rally new technologies but may simply lack creativity in their individuals.

Smaller companies, on the other hand, may lack funds and expertise but may make up for it in terms of novel ideas and new technology as they are not bound by red tape.

Bigger companies hence tend to gain a lot from merging with or acquiring smaller companies as they can benefit from their intellectual property while nurturing that technology to reach scales that wouldn't have been possible for them otherwise since they lack the infrastructure to do so.

3. Gain Operational Synergies

A strategic merger can help companies gain operational synergies which is essentially when the performance of two firms combined is much greater than what they could have achieved otherwise.

Ideally, all mergers should feature operational synergies, as the essence of a merger wouldn't make sense without it.

Companies can gain operational synergies by teaming up against the competition and acquiring large chunks of their customer base.

Even if two average players in the market merge, they could create an overlap and stand at the highest market share in the entire industry.

Companies could also gain operational synergies by:

  • cutting costs,
  • consolidating overlapping operations,
  • letting go of redundant facilities.

4. Diversify Investments

It is not uncommon for big companies to merge with or acquire smaller unrelated businesses that they have no experience with whatsoever.

This is also known as a pure conglomerate merger, and a fictional example would be a television broadcasting company acquiring a fast food chain. While this type of merger may seem like a bad decision, it is very smart.

By venturing into unrelated businesses, while companies are expanding into businesses that are not an area of their expertise, they are also making an effort to diversify their investments and not keep all of their eggs in one basket.

This is a smart growth strategy as the decline of one business may not equal a decline in the other, as is the case when companies venture into related mergers.

5. Make R&D More Efficient

Generally, when a growth team comes up with the idea to venture into a new and growing field of business, the idea is met with tons of research and years spent in planning.

The actual business is set up years after the team first planned it, and the business opportunity may as well have gone away by now.

Instead of doing their research into forming a new venture, companies can simply look up successful and growing firms in that field and merge with or acquire them.

This way, the company wouldn't have to spend years on paperwork and can focus on its core business while also paying attention to this new venture.

Disadvantages of M&A as Business Growth Strategy

  1. Raise Valuation Challenges
  2. Create Financial Burden
  3. Create Management Burden
  4. Create Lack of Flexibility
  5. Integration Issues

1. Valuation Challenges

The history of M&A is littered with overvalued mergers and acquisitions.

By now, most are familiar with the textbook examples of AOL and Time Warner or Quaker Oats and Snapple, but the truth is, these are just a handful of the thousands of companies that are overvalued on an ongoing basis.

This isn’t easy to avoid.

To push through what initially appear like attractive transactions, those in charge of the M&A process often feel obliged to meet sellers’ value expectations, hoping that the overpay will be made back during integration.

And even those transactions that appear to be fairly priced on the surface can turn out to severely overpriced.

Read also: A Review of Business Valuation Methods

2. Financial Burden

Although the idea of a roll-up strategy is attractive, many companies will inevitably eventually look to acquire a larger company that places pressure on the company financials.

The scale of these transactions, often which involve large amounts of cash in the form of debt, tends to place undue pressure on the balance sheet.

As a result, the operational efficiencies that a company aimed to achieve through the transaction are often lost via interest payments on the debt.

The more debt that the deal involves, the more pressure on the company’s managers to maintain income above a certain level.

3. Management Burden

Management time devoted to a deal is a key success driver for M&A. Management simply cannot afford to neglect deals which form a core part of the company’s strategy.

However, this means that deals create a management burden on top of what they’re already to contend with.

Even with a good corporate development team in place, management will need to have varying degrees of involvement in the transaction in from the origination through due diligence and on to closing and deal integration.

The big danger here is that routine tasks are overlooked in favor of the deal-related tasks, causing company’s progress to stutter as a direct consequence of the M&A transaction.

4. Lack of Flexibility

All things being equal, the larger an M&A transaction, the less flexibility the acquirer has. Essentially, an M&A transaction is a one-way bet on the company’s chosen strategy.

Although in theory it’s possible to resell an acquired company or to break up a merged entity, the practice of doing so is usually extremely costly.

This lack of flexibility should be at the forefront of the thinking of anybody undertaking M&A.

Closing M&A deals usually means less cash available for other opportunities when they arise, less management time, and arguably most importantly, less flexibility to endure negative growth in the business cycle. 

5. Integration Issues

Even experienced M&A practitioners can find post-merger integration extremely challenging. Companies that seemed to be similar on the surface can turn out to be markedly different after the ink has dried on the share purchase agreement.

A good example of an integration issue is culture. Inexperienced M&A participants have a tendency to understate its importance to extracting value from a deal.

If you’re not willing to invest the time in the post-deal integration, believing that it should play out on its own, you should postpone closing a deal until a time when you can dedicate the resources to this process. 

Conclusions

Conducted well, M&A transactions are unquestionably the best way for companies to achieve marketing-beating growth.

However, achieving growth isn’t quite as simple as closing deals.

Anybody looking to begin a merger or acquisition should consider the advantages and disadvantages of both to maximize their chances of success.

dealroom

Mergers and acquisitions are a popular growth strategy for companies hoping to expand into new markets, rise above competition or acquire new skill sets in their industries.

The rapidly changing economy fuelled by technological advancements calls for companies to rapidly enhance the scale of their operations, which can only be made possible through mergers.

Mergers are essentially done for two reasons and those are either monetary or strategic. While monetary mergers are pursued for the sake of investment, strategic mergers are the real deal and are pursued to solve your company’s problems.

Whether your company may be in need to acquire a certain factory or exclusive partnership, venture into a new product line, or enter a new market.

We at DealRoom help dozens of companies organize their M&A process and below, we look at the advantages and disadvantages of using M&A for your company’s growth strategy. We begin with the advantages.

Advantages of M&A as Business Growth Strategy

  • Allow to Increase Service Offering
  • Allow to Acquire Intellectual Property
  • Gain Operational Synergies
  • Help Diversify Investments
  • Make R&D More Efficient

1. Increase Service Offering

Changing laws and regulations can often create gaps in your company’s service offerings. Even if the gaps aren’t brought about by a change in laws, it could simply be a pre-existing gap that you never thought to fill.

Filling in such gaps can be accomplished by a strategic merger. 

For instance, a construction company in Texas may look to merge with or acquire an order supply fulfillment firm in California to expand its service offering. Not only would this create more construction jobs texas, but it would also lead to pertaining growth in California too.

2. Acquire Intellectual Property

Many giants in most industries have the funds and expertise to rally new technologies but may simply lack creativity in their individuals.

Smaller companies, on the other hand, may lack funds and expertise but may make up for it in terms of novel ideas and new technology as they are not bound by red tape.

Bigger companies hence tend to gain a lot from merging with or acquiring smaller companies as they can benefit from their intellectual property while nurturing that technology to reach scales that wouldn't have been possible for them otherwise since they lack the infrastructure to do so.

3. Gain Operational Synergies

A strategic merger can help companies gain operational synergies which is essentially when the performance of two firms combined is much greater than what they could have achieved otherwise.

Ideally, all mergers should feature operational synergies, as the essence of a merger wouldn't make sense without it.

Companies can gain operational synergies by teaming up against the competition and acquiring large chunks of their customer base.

Even if two average players in the market merge, they could create an overlap and stand at the highest market share in the entire industry.

Companies could also gain operational synergies by:

  • cutting costs,
  • consolidating overlapping operations,
  • letting go of redundant facilities.

4. Diversify Investments

It is not uncommon for big companies to merge with or acquire smaller unrelated businesses that they have no experience with whatsoever.

This is also known as a pure conglomerate merger, and a fictional example would be a television broadcasting company acquiring a fast food chain. While this type of merger may seem like a bad decision, it is very smart.

By venturing into unrelated businesses, while companies are expanding into businesses that are not an area of their expertise, they are also making an effort to diversify their investments and not keep all of their eggs in one basket.

This is a smart growth strategy as the decline of one business may not equal a decline in the other, as is the case when companies venture into related mergers.

5. Make R&D More Efficient

Generally, when a growth team comes up with the idea to venture into a new and growing field of business, the idea is met with tons of research and years spent in planning.

The actual business is set up years after the team first planned it, and the business opportunity may as well have gone away by now.

Instead of doing their research into forming a new venture, companies can simply look up successful and growing firms in that field and merge with or acquire them.

This way, the company wouldn't have to spend years on paperwork and can focus on its core business while also paying attention to this new venture.

Disadvantages of M&A as Business Growth Strategy

  1. Raise Valuation Challenges
  2. Create Financial Burden
  3. Create Management Burden
  4. Create Lack of Flexibility
  5. Integration Issues

1. Valuation Challenges

The history of M&A is littered with overvalued mergers and acquisitions.

By now, most are familiar with the textbook examples of AOL and Time Warner or Quaker Oats and Snapple, but the truth is, these are just a handful of the thousands of companies that are overvalued on an ongoing basis.

This isn’t easy to avoid.

To push through what initially appear like attractive transactions, those in charge of the M&A process often feel obliged to meet sellers’ value expectations, hoping that the overpay will be made back during integration.

And even those transactions that appear to be fairly priced on the surface can turn out to severely overpriced.

Read also: A Review of Business Valuation Methods

2. Financial Burden

Although the idea of a roll-up strategy is attractive, many companies will inevitably eventually look to acquire a larger company that places pressure on the company financials.

The scale of these transactions, often which involve large amounts of cash in the form of debt, tends to place undue pressure on the balance sheet.

As a result, the operational efficiencies that a company aimed to achieve through the transaction are often lost via interest payments on the debt.

The more debt that the deal involves, the more pressure on the company’s managers to maintain income above a certain level.

3. Management Burden

Management time devoted to a deal is a key success driver for M&A. Management simply cannot afford to neglect deals which form a core part of the company’s strategy.

However, this means that deals create a management burden on top of what they’re already to contend with.

Even with a good corporate development team in place, management will need to have varying degrees of involvement in the transaction in from the origination through due diligence and on to closing and deal integration.

The big danger here is that routine tasks are overlooked in favor of the deal-related tasks, causing company’s progress to stutter as a direct consequence of the M&A transaction.

4. Lack of Flexibility

All things being equal, the larger an M&A transaction, the less flexibility the acquirer has. Essentially, an M&A transaction is a one-way bet on the company’s chosen strategy.

Although in theory it’s possible to resell an acquired company or to break up a merged entity, the practice of doing so is usually extremely costly.

This lack of flexibility should be at the forefront of the thinking of anybody undertaking M&A.

Closing M&A deals usually means less cash available for other opportunities when they arise, less management time, and arguably most importantly, less flexibility to endure negative growth in the business cycle. 

5. Integration Issues

Even experienced M&A practitioners can find post-merger integration extremely challenging. Companies that seemed to be similar on the surface can turn out to be markedly different after the ink has dried on the share purchase agreement.

A good example of an integration issue is culture. Inexperienced M&A participants have a tendency to understate its importance to extracting value from a deal.

If you’re not willing to invest the time in the post-deal integration, believing that it should play out on its own, you should postpone closing a deal until a time when you can dedicate the resources to this process. 

Conclusions

Conducted well, M&A transactions are unquestionably the best way for companies to achieve marketing-beating growth.

However, achieving growth isn’t quite as simple as closing deals.

Anybody looking to begin a merger or acquisition should consider the advantages and disadvantages of both to maximize their chances of success.

dealroom

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