Strategic Maneuvers

Gaining a competitive advantage for the mid- and small-market businesses

In response to McKinsey & Company’s published article, “M&A as Competitive Advantage,” Bart Basi and Marcus Renwick explore the usage of M&A as part of a larger strategy, rather than a stand-alone deal. Special focus is given to the benefits relating to mid-market and small, closely held businesses, where the bulk of M&A action occurs.

McKinsey & Company

This overview contains observations based on McKinsey & Company’s article, “M&A as Competitive Advantage”, published in the firm’s Insights & Publications, August 2013.

When people hear the words, “merger” or “acquisition,” thoughts of Fortune 500 mergers, more often than not, come to mind.  They grab the headlines.  The reality is that the largest mergers in the history of the world happened within the past 20 years.  For most of us, these business mergers do not affect our daily lives.  However, for the small- or mid-sized business owner, mergers and acquisitions (M&A) can be the key to a more successful, longer-lasting business.

Merger and acquisition involves the M&A activity of businesses of any size.  Middle-market mergers and acquisitions have been a big part of the merger and acquisition activity. This involves transactions between $10M and $100M.  In fact, in recent years, middle-market activity has accounted for roughly 45 percent of M&As.  This activity is roughly 10 times the amount of activity the large mergers have been experiencing.  The remaining merger activity involves the small, closely held company.  Many of these smaller transactions are not even publicized.  Yet they account for over 50 percent of all M&A activity in the United States.

Merger and Acquisitions are integral to the advancement of multiple goals, such as:

1. Business Longevity

Human life is finite in years.  Corporate life is indefinite.  Often, entrepreneurs open and run businesses during their lives.  Unfortunately, upon their death or retirement, the business ceases to exist.  This is a negative occurrence, not only because a source of family wealth disappears, but also because the jobs associated with the business evaporate, as well.  This is one important reason why mergers and acquisitions are so important for all business owners today.

A number of business-succession methods exist.  A merger or acquisition can extend the life of a business beyond the life of the original owner.  To do this, the business owner must find a business suitable to merge or acquire.  Considerations such as type, price, location, age of the management, and the like should be kept in mind when considering merging.  Once the target company is found, the two businesses can be combined.  Once combined, the new business will have the size and revenue necessary to carry on without the involvement of the original owner.

2. New Markets

New markets can also be broken into by means of a merger or acquisition.  Entering a new market on your own may be hard or even impossible.  With the use of a merger or acquisition, the business owner merely buys his or her way into a new market quickly and efficiently.  Many businesses can operate well with another business in the same industry.  This allows management to run both businesses with little or no training.

3. Contain Supply Chain Costs

Along with entering new markets, supply chain costs can be reduced.  Recently, a television station paid a supplier for use of its movies.  The supplier then raised the costs of the movies to a price beyond a profitable amount for the station, which had to stop showing movies.  This resulted in the supplier losing a lot of money and considering bankruptcy.   Instead of going bankrupt, the television station bought the supplier.  The supplier management was then fired.  The new management then effectively reduced the cost of the movies to the station. Both companies became profitable.  This is an extreme example of how supply chain costs can be reduced, and a vivid example at that.  If your business frequently uses a large quantity of materials from a common supplier, it may be more cost effective to buy your supplier than to deal with the problem.

4. Increase Production Capacity

In addition to cost savings, mergers and acquisitions can have the effect of correcting other weaknesses in the business.  Often, businesses suffer from poor capacity in their product line.  Acquiring another business in the same product line can increase capacity.  Furthermore, expertise belonging to the target company can become the property of the acquiring business.

How To Prepare To Sell 

Recent technological developments have made selling a business easier.  Sellers can now advertise their business on the internet with the assistance of an agent and/or business broker. 

Selling a business requires good timing, which means access to capital to finance the acquisition and a stable and predictable business and regulatory environment.  As baby boomers are getting set to retire and pass on their business, they must take market forces into account.  This requires that the owner(s) engage in much planning, preferably well ahead of time.  If this is not done, the retiree may either have to delay retirement or accept a far lower price than what was envisioned, and perhaps even warranted..  Therefore, it is beneficial for the seller to know what kind of deal is good for the business in advance and seize the opportunity.

1. The first step in selling a business is to obtain a detailed valuation (at the very least, a calculation that considers two approaches) of the business.  This will allow you to see what your business is potentially worth in its current state, based on market conditions.   The owner can then try to sell it for the price it is valued at or hold onto the business and make changes that may enable it to be more attractive to strategic or financial buyers at some future time.

2. Next, the company must be marketed to potential buyers.  A list of potential buyers should be drawn up, contacted, and screened before offers can be accepted.  This step requires patience.  Not all buyers are ready to buy a company for the price asked.  This step can potentially take several months.

3. Once the potential buyer(s) express an interest in participating in the process, offers should come.  In the best of all cases, the seller will then decide which offer is best, and it may not be the highest.  The agent of the seller should guide his or her client through all steps of the sale, including negotiations, due diligence, and consummation of the deal. 

It is critical that the seller have competent, licensed advisors and legal counsel throughout this selling process.  A valuation that is too low can easily eliminate millions of dollars the seller is entitled to in a transaction.  An offer that is considered too high will not generate interest. If the business is marketed and sold to the wrong buyer, the seller could again potentially lose millions of dollars.  Therefore, it is imperative for the seller to have competent agents throughout the process of selling a business.

Buyers Need To Be Ready To Recognize Value and Execute

Buying is different from selling a business.  Instead of the valuation of the seller being important, knowing the firm can afford to pay is critical. It is important for buyers to know that today, 40-50 percent of the M&A costs can be financed.

1. It is important to have an acquisition strategy.  The purposes described in this article should serve as a good outline of possibilities to look for when planning a merger or acquisition.  Having a strategy ahead of time will allow you to jump into a business transaction when the opportunity arrives and not six months later. Think of the time you saw an item on sale, but did not realize you would gain by buying at that time.  Then you waited, and the item went off sale. The next time you went into the store and saw the item at regular price, you realized you should have bought it when it was on sale.  Has this ever happened to you?  Planning will prevent this from happening to the buyer.

2. Be proactive.  When planning for an M&A, the buyer should project cash flow, recognize what is sustainable, and understand the value proposition of the target company.  Stated otherwise, the buyer needs to understand that there is a limit on what can and should be spent in the acquisition.   Having this settled beforehand and having financing set up can allow the business owner or board to seize an opportunity when it arises as opposed to watching the opportunity run away.

3. Focus on the future.  The acquirer needs to assess the merits of integrating the firms and where integration is warranted.   Plans made ahead of time can prevent confusion in the future.

4. Most of all, when hoping to buy a business or perform other M&A activity, remember that patience is important.   M&A activity does not happen overnight, and those that were not part of the strategic plan or involved in the decision to pursue a merger will have significant questions about their role and what is expected from them.    Sometimes the deals take years to hammer out.  The important thing in these transactions is to be as proactive as possible when planning, and then be patient when doing it.

Conclusion

M&A activity is increasing once again.  The consensus is that M&A activity will continue to increase in the coming years.  Your business or that of a client can gain a competitive edge in developing a strategy utilizing M&A, not as a one-time thing, but as an ongoing endeavor.  Knowing what to look for and planning ahead can lead to a successful and beneficial merger or acquisition for both parties.  A successful merger or acquisition can improve your business through a number of ways including geography, production, or market.  As the population ages and the market picks up, business owners should be aware of and investigate opportunities that can be beneficial.

Business owners may need to better understand the opportunities and challenges of this strategic option.  Clients are best served by professionals who understand the business industry, the competitors, demand for the product, the innovation taking place, and the process of selling or buying a business.

Dr. Bart A. Basi is an expert on closely held enterprises.  He is an attorney, a certified public accountant, and the president of the Center for Financial, Legal & Tax Planning, Inc.  He is a member of the American Bar Association’s Tax Committees on Closely-Held Businesses and Business Planning.

Marcus Renwick is an attorney and the Director of Research and Publications with the firm.  You can reach the authors at:  marcus@taxplanning.com.