Two companies might be worth something apart, but when combined, these companies become way more valuable. This is what it means to achieve the perfect synergy in M&A transactions.
Today’s market is ripe with opportunities for M&A activity. In the face of robust debt and equity capital markets, PE firms are leveraging this environment and taking a step away from platform acquisition and instead focusing on add-on acquisitions, where portfolio companies are building through acquisition. In doing so, PE firms are leveling the playing field: corporate buyers contribute businesses with potential synergies and PE firms bring the expertise necessary to capture these synergies.
While add-on acquisition invites more competition amongst PE, there is also a tremendous amount of value in realizing the potential synergies in mergers and acquisitions.
Sellers and buyers alike are becoming more sophisticated, revealing opportunities where synergies can provide terrific growth and value. For the buyer, knowing what synergies exist can uncover the maximum price at which a company can afford to pay for the target. The seller, on the other hand, benefits from understanding potential synergies because they can rationalize higher purchasing costs. No matter who is involved, recognizing the synergies that exist between one combination of businesses to the next is crucial when preparing for the sale of a business.
In the era of add-on acquisitions, knowing the synergies at play will make or break your performance.
Types of Synergies
There are several types of synergies at play during merger and acquisition activity. Understanding how each synergy works in different scenarios will help you identify the best combination. For example, even though Company A and Company B offer more together, Company A and Company C might actually lack synergy depending on the business. It’s important to recognize synergies and learn how to capture these for greater value creation.
1. Cost Synergy
In the event of a merger or acquisition, cost synergies reduce costs when the right companies come together. The impact of this can be felt amongst many departments and industries, as the result of successful synergies can give you access to a new segment of customers, save you money on logistics, storage, training, and marketing, and importantly consolidate common business functions, systems integrations, and premises reductions.
In particular, if one company seeks to achieve cost savings through M&A activity, they tend to:
Reduce duplicate staff;
Share information technology for increased operational efficiency;
Provide access to supply chain relationships;
Improve distribution sales and marketing channels;
Consolidate systems and suppliers;
Exchange best-practices and research and development efforts;
Increase the use of capital assets, including factories or transportation;
Consolidate locations; and
Decrease professional services fees.
One thing to keep in mind is that cost synergies should also be considered on a net basis because integrating businesses takes time and money. Remediating websites, integrating systems, training staff, and eliminating surplus staff is a timely process, but if done correctly, substantial cost saving cans be realized within two years of a deal, notably reducing overall costs and freeing up space for you to focus on growing the business.
2. Revenue Synergy
Revenue synergies exist when two companies merge and sell more products or services than they did when they were separate. Putting this into perspective, let’s say Company A maintains a revenue of $400 million and Company B has a revenue of $50 million. Once these companies merge, their new revenue is projected to be worth $500 million, creating revenue synergies of $50 million. To find out what it takes to be successful, PE firms must identify where there are areas of value and how to prioritize these opportunities.
Some of the most revenue enhancing synergies that occur when two companies merge include:
Bundling products post-merger to generate higher sales to customers;
Creating access to patents;
Increasing demographic access; and
Leveraging existing client relations, distribution network, and sales force.
While revenue synergies can present ideal economics for buyers and sellers, it is critical to note that quantifying revenue synergies is inherently speculative in terms of both value and time. For example, 50% of the estimated synergy might be captured in the first year of integration; however, it could take another year or two for full synergies to be realized. Additionally, the value of revenue synergies can vary from hardly any to extremely optimistic. Without exploring all the possibilities surrounding revenue synergies, the purchaser might fail to set realistic targets or accurately measure the financial impact, resultantly focusing on the wrong things. By fully understanding the sources of revenue synergies and thoughtfully quantifying opportunities, you can build a revenue synergy strategy that is worthwhile.
3. Financial Synergies
Last, but not least, are financial synergies. Financial synergies help small to mid-market sized companies secure funding sources to finance their businesses. For instance, if one mid-level company requests a loan from a bank, they might have to pay a premium for taking loans or increased interest; however, if two mid-level companies join forces and ask for a loan, they will experience several financial advantages because they have better capital structure and more cash flow.
Some of the key benefits of financial synergies include:
Paying less interest;
Additional tax benefits;
Increased debt capacity; and
Reduced cost of capital.
To get the most value from financial synergies, the income statements of each company must be evaluated pre-merger in order to determine whether or not the combined statements will generate positive synergy. Tracking and measuring metrics will help you fully capture financial synergies.
No matter what type of synergy you’re after, having the ability to recognize and capture potential synergies that flow from an M&A transaction is essential to rapidly implementing cost savings and generating higher sales. Whether working with platform or add-on acquisitions, buyers and sellers need to take a strategic approach to expanding their business, and synergies offer just the right amount of leverage to boost your growth potential.
Successful M&A strategy and execution is dependent on how well you know the business you’re in and knowing where you want to be in the future. Looking at potential synergies, you will strategically position your acquisition worth more as a whole than its parts, capturing sophisticated, clear synergies for real value.