In 2020, mergers and acquisitions deals were valued at $2.8 trillion worldwide. This number involves so many zeros, you may be wondering about the motives for mergers and acquisitions.
Reasons for mergers and acquisitions (M&As) vary. Some companies buy other companies for strategic purposes, such as increasing market share and gaining access to resources. Others do it to avoid taxes or to stroke the egos of top executives.
In any case, M&As are high-stakes transactions that involve meticulous and tedious work. However, companies that engage in M&As are motivated by the promise of great rewards. Let’s take a look.
Motives for mergers and acquisitions: Why do companies acquire other companies?
Now let’s take a closer look at what drives companies to engage in painstaking M&A deals. Why do companies merge?
1. Value creation
Companies may engage in an M&A to achieve synergy, where the resulting business is greater than the sum of the aggregate parts of the combined firms. That is, the merging companies are able to create more value once they’ve combined their assets or business operations. Synergy comes in two forms:
- Cost synergy: Combining two companies may result in a more efficient cost structure that benefits from pooled resources and cutting-edge technology.
- Revenue synergy: Merging with or acquiring another firm may improve a company’s ability to earn revenues as it engages in intensified R&D, market expansion, and product diversification.
2. Economies of scale
One reason larger companies are more competitive is that they benefit from economies of scale. That is, larger firms can reduce their costs as they increase production. For instance, a company that orders raw materials in large quantities can negotiate better prices and manufacture products at a lower cost.
As you can see, this is somewhat related to value creation — merged companies have access to more resources and are better able to scale their operations.
3. Market share
The company that has the resources to acquire the lion’s share of the market becomes ‘too big to fail’. CEOs are always on the lookout for ways to increase market share, and M&As are one of the most effective ways to do so. As a matter of fact, many major industry players grew by acquiring smaller companies.
Companies are not only out to expand their market share but to capture new markets as well. They may use a merger to offer new products and services. You’ll also find firms that engage in M&As to reach foreign markets.
5. Vertical integration
Firms sometimes acquire companies that form part of their value chain. Called vertical integration, this strategy allows businesses to streamline their operations by cutting out external contractors and taking ownership of various production stages.
For example, a firm may acquire a distribution company to eliminate the margin or layer of costs the latter adds to the value chain.
6. Acquisition of new expertise
Companies that fail to keep up with the rapidly changing business landscape are less likely to survive. This is why firms are willing to merge with companies that can bring in new expertise or technology. Case in point, many oil companies are now acquiring renewable energy firms to meet shifting consumer sentiment.
Companies may not be quick to admit it, but tax avoidance is one of the reasons they participate in M&As. A firm that’s cash-flow positive can merge with a company that has a tax loss carryforward. This way, the consolidated company can significantly reduce its total tax liability.
8. Financial capacity
Companies have a ceiling when it comes to their financial capacity. Merging with another company allows them to expand this capacity and invest more in their business development processes.
In some cases, firms acquire a company for its positive cash flow. This is usually the reason private equity firms engage in M&As.
An M&A sometimes happens because the top-level managers find the deal beneficial on a personal level. In cases like this, the deal often results in increased power and prestige for top management. Moreover, the firm’s size and manager compensation are positively correlated. This means that the bigger the company, the larger the management’s compensation package.
The executives may also be engaged in ‘empire building’ (which is often driven by ego — not good business sense). That is, they aim to build the largest company in the industry.
There are cases when the deal simply falls into the lap of managers. A company is offered for sale below its intrinsic value, and they decide to grab the rare deal. As you can see, the motives are numerous.
Why M&As need virtual data rooms
Mergers and acquisitions often fall through. Failed deals happen because of poor execution, bad research, and a lack of transparency and communication between parties. Companies can avoid the same fate with the right tools and adequate preparation.
According to a 2020 M&A Trends report by Deloitte, digital tools are considered the best way to accelerate due diligence, a process that contributes greatly to the success of M&As. Survey respondents like how these tools provide insights and help them work through uncertainties.
Virtual data rooms for M&A are particularly popular in this arena. Deal room software provides a repository of data that multiple parties can access without compromising security. A virtual deal room offers a platform for parties from both the buy sides and sell sides of the deal to share and closely study documents and files.
M&As involve large amounts of confidential documents and sensitive information. Fortunately, M&A data rooms have innovative VDR security features to prevent data breaches and leakages.
Data room software for M&A is also equipped with project management tools that allow administrators to steer the due diligence process to completion and document control tools that enable stakeholders to do their job efficiently.
Read more about Why Modern M&A Requires a Virtual Data Room
To sum up
There are many valid and exciting reasons to get involved in M&As. While these deals can be immensely rewarding, they come with risks that can throw large amounts of money down the drain.
Fortunately, the right digital tools can help you avoid the traps that have resulted in so many companies failing to complete their M&A deals.