Updated Feb 11, 2024
Shareholders and stakeholders in virtually every company believe that those companies should be managed to create as much wealth as possible. And that means that resources should be managed to achieve that goal. While there are scores of ways for companies of all sizes to increase revenues and reduce costs, one effective way is to take advantage of the cost synergies in M&A.
What Are Mergers and Acquisitions?
Mergers and acquisitions (M&As) are legal transactions in which two companies (or divisions thereof) perform a consolidation of assets. It can be the result of one company taking over another (or a division of it) or the formation of a new entity by the consolidation of two companies. In addition, there are other lesser-used types of mergers and acquisitions, including tender offers, acquisitions of assets and management acquisition.
Simply put, the main impulse behind an M&A is typically financial or business reasons. Whatever the motivation is — increasing profit, acquiring assets, increasing market share or reducing risk — those are what drive these strategic decisions. The reasons for doing this are numerous — mostly financial or business related — but in most cases, the end result is to create value. And one way that companies create value is by merging and creating a successful synergy.
What Is Synergy in M&As?
Synergy is the interaction of two (or more) agents or forces so that an enhanced combined effect is achieved. Simply put, it’s when the whole is greater than the sum of the parts. That’s an old cliché, but it has meaning in the business world (among other places), particularly in M&A dealings.
In the business world, synergy is when the combined value of two separate companies is greater than the value of both companies added together. So if company A has a pre-merger value of $100M and company B has a pre-merger value of $22M, the new company formed by the merger of A and B might have a value of $155M, greater than the sum of $100M plus $22M. In this instance, there is a $33M synergy for the merger.
Sources of Synergy
But where does this extra value come from? There are several reasons why firms merge or acquire each other. In most instances, there are tremendous cost savings from efficiencies of the combined firms, or perhaps from additional incremental revenues. In addition, there are other, more subtle ways that merger synergies are measured. An example of this is that the new common corporate culture can lead to a more successful firm.
3 Types of M&A Cost Synergies
There are many different types of cost synergies that merged companies strive for, and almost always for the goal of increasing revenue and lowering costs, as synergies can achieve one (or both) of those goals. Revenue upside M&A synergies include:
1. Patents
If the merged company gains patents or intellectual property from one of the pre-merger companies, it has the ability to create more revenue by having access to those intangible assets.
2. Complementary Products
If both companies were producing complementary products or services before the merger, they now have the ability to increase sales by creatively bundling (and marketing) those products or services.
3. Geography and Customer Base
Similar to the products example, the merged firm can take advantage of the combined geographical areas and customer base.
In addition to increased revenue, there are cost savings that are possible with a merger. Some of these cost saving synergies include:
- Technology: The proprietary technologies that each company has are easily able to promote operational efficiency for the merged company.
- Supply chain: Similarly, if one of the companies has better access to supply-chain relationships, there is another cost savings that can be realized.
- Research and development (R&D): Again, the company that has brought an advanced R&D department to the table can help cut costs by applying it to the entire company.
- Patents and licensing: If one of the pre-merger firms was paying the other for patents or licensing, that entire expense will be eliminated.
How To Analyze M&A Cost Synergies
There are probably as many ways to estimate M&A synergies as there are types of M&A. Some examples include:
- Head count: Through analyzing head count, any redundant staff can be eliminated.
- Real estate: Similar to head count, redundant or unused space can be eliminated and taken off the books.
- Hard assets: This is another similar synergy, as redundancy in this area can also be eradicated.
- Consolidation of vendors and contracts: Now that the new firm is larger, it may be able to negotiate better terms and contracts with suppliers and contractors. Knowing the right acquisition negotiation tactics to use can help make this process smoother.
- Speed to market: A combined company may find itself with enhanced distribution and market share, gaining the ability to quickly penetrate new geographical areas far more quickly and cheaply than before the merger.
- Efficiency: Sharing best practices from the experience of both pre-merger companies often improves operational efficiency at the new firm.
Of course, there are risks, as no deal is guaranteed to be successful. In many instances, short-term costs may actually increase as a series of one-time expenses are incurred. Typically, it takes two to three years for the financial synergy to become effective; this is known as the phase-in period.
What Tools Are Necessary?
No matter the industry, M&A transactions are now typically handled online. A new type of data room is required, one that cuts both the expenses and time required in order to complete the transaction. A virtual data room (VDR) is an online room where companies can store, share and access sensitive and confidential data. A VDR gives administrators tremendous security options, including secure file transfer, allowing certain parties to access only certain documentation, as well as timestamp and tracking options, which certainly streamline and expedite any of these transactions.
In Closing
For any company that is merging and looking to take advantage of the cost synergies that are part of the plan, partnering with a trusted third-party data-room provider will help streamline the process, both logistically and financially. CapLinked, a leader in the VDR space, offers solutions that are as easy to use as they are secure. Learn more about CapLinked’s cutting-edge VDRs by trying a free trial today.
Chris Capelle is a technology expert, writer and instructor. For over 25 years, he has worked in the publishing, advertising and consumer products industries.
References:
- Corporate Finance Institute (CFI). What are Synergies? Revenue, Cost, and Financial Synergies Explained. https://corporatefinanceinstitute.com/resources/valuation/types-of-synergies/
- Wall Street Prep. What are Synergies in M&A? https://www.wallstreetprep.com/knowledge/synergies-revenue-cost/
- McKinsey & Co. Making M&A deal synergies count. https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/making-m-and-a-deal-synergies-count
