Mergers and acquisitions can be a very important play regarding strategic growth for companies. A merger or acquisition can yield much higher returns on growth as compared to a company trying to grow organically and independently. Traditionally, M&A deals would take place to achieve scale within an industry or reduce costs, but now, acquisition deals are looked at in a much broader scope to try and identify new opportunities or integrations of complementary goods and services. A look at value creation and synergies, therefore, becomes an important part of such investment deals.
Sirower (1997) defines synergies as “increases in competitiveness and resulting cash flows beyond what the two companies are expected to accomplish independently”. Moving beyond just cash flow, the concept of synergies applies to creating added value by sharing resources and acquiring benefits that otherwise would not have been possible to achieve, or would have been achieved at a higher cost. Simply put, instead of 1+1=2, the concept of synergies states that 1+1=3 through creation of added value.
Synergies are important because they provide the deals a direction in terms of current financials and operations, new innovations and future plans. They help you identify and assess what is currently going on within the business and what can be improved upon once the two businesses are combined.
Synergies can take on many forms depending on the type of M&A and the organization’s business. Synergies mainly occur in the following:
Synergies decreasing the costs – Resources and competencies that do not use their full capacity (100 %) or do not work effectively can be better utilized if combined with new, additional or related activities that extend the usage thanks to decreased average costs
Synergies increasing the revenues – extensions of customers and products, and cross-selling or bundling
Synergies related to decreased costs of capital through lowered risks, better cash flows and increased financial margins
Synergies related to higher margins are achieved through increased negotiation capabilities towards suppliers and customers
The categorizations above give a good indication of what areas the synergies occur and where the business’s finances can be saved or gained, but in reality, actual synergies often belong to more than one type and may even overlap.
How does value creation through acquisitions promote growth?
Broadly speaking for any organization, there are two ways to grow: organically or through an M&A. Growing organically means investing your own resources and capabilities to grow the company, whether it is sales, marketing, technology or operations, to grow your revenue. Depending on market conditions and company requisites, organic growth may help you scale quickly or slowly, and may work to a smaller or larger extent. Organic growth may also be insufficient to meet shareholder expectations. M&A’s may provide a better option to grow (strategically) and here is where M&A’s and synergies become topical.
While thinking of synergies, both horizontal and vertical expansions can be looked at; but looking into goods or services complementary to yours is a great start when thinking of acquisitions. This goes for both the buy-side as well as the sell-side companies. Value can be created for both sides of the deal in many forms – through resource sharing, improving efficiencies, market-entry speed gains, competitive gains, knowledge sharing and learning curve, and many more. Pinpointing these synergies as accurately as possible helps create maximum value from an M&A deal and can lead to growth in multiples.
The McKinsey framework below is a great example of how synergies can be understood. It provides for a very valuable method of analyzing different synergies to maximize the value created from a deal. An M&A helps companies combine their current capabilities but it is also a window into what transformational opportunities can be opened up to, indeed, transform the futures of both companies.
Value creation for startups
Fundraising is a difficult aspect of starting up any business. While initial investments are scrutinized heavily by investors and require patience, raising further investments means even more scrutiny and patience. For startups and other small businesses, the value created through an M&A can provide a plethora of opportunity and accelerated growth. Whether a buy-side or sell-side company, you can build upon your revenues and customers, bring in new technology and knowledge, share resources and cut costs where unnecessary. An M&A could provide the very opportunity to strategically scale up while ensuring benefits for the long term.