All businesses have one common goal in mind: growth.
After all, it’s one of the vital ingredients that make up a company’s long-term success. Although there are many different strategies that can foster growth, companies often choose business acquisitions as their primary approach towards dominating the market.
We, at DealRoom, work with hundreds of companies and corporate development teams helping their business grow through acquisitions, and here’s what we’ve learned from them.
Acquisitions are very common in business. It can occur with or without the target company’s approval.
However, if the target company approves the purchase, a no-shop clause will be established between the two parties. A no-shop clause prohibits the target company (seller) from soliciting sales from other interested buyers.
It’s common to hear about business acquisitions done by larger companies. But in reality, most business acquisitions happen between small- to medium-sized enterprises.
Why Companies Acquire Other Businesses
A merger or acquisition can be a viable strategy for a business to expand and improve their profitability ratios. Specifically, businesses, regardless of their size, engage in acquisitions for the following reasons:
1. To enter a foreign market
One of the most popular ways that businesses expand is by going international. Businesses do this by acquiring a company from a specific country, thus improving their scope and reach.
Purchasing a foreign company is also the easiest way to penetrate that country’s market.
Plus, since the target company already has established roots in that particular country or area, it will be an easier and smoother transition for the new management to take over.
2. Qualified talent and intellectual property acquisition
Once a business acquires another business, in most cases, it also absorbs its staff and intellectual property. This is particularly beneficial if the acquiring company is experiencing a need for a particular talent or they’re looking to take over intellectual property.
For instance, an acquiring company might not have an engineer on board, but the target company might have a few.
As the acquiring company completes the transaction for the acquisition, they can then absorb the engineers along with the target company’s intellectual properties, which can then be bought and sold, making it easier for the company to achieve market growth.
3. Quicker way to expand product or service offerings
Business acquisitions can also happen if the buying company is looking to expand its services or offerings.
For example, perhaps a company may need logistics to provide a better service to their clients. Instead of spending time, money, and effort towards developing the service, it might make more sense to acquire the service.
That said, they may buy a logistics company and merge their operations to expand the services the company offers. This, in turn, improves efficiency and adds another revenue stream for the acquiring company.
4. Accelerated growth and overcoming competition
Aside from that, acquisitions also help speed up the company’s growth, which helps overcome competition much quicker.
Organic growth, or growth achieved by increasing output and internal sales, doesn’t happen overnight. Sometimes, it could take years to double a company’s size.
With a business acquisition, on the other hand, the acquirer can take over a new company (usually one that isn’t in the same industry but is closely related) and absorb their services/products, staff, and departments, essentially increasing revenue.
That said, businesses can eliminate duplicate departments and facilities, thus reducing costs. Not only that, but the company can also upsell or cross-sell their services or products with the acquisition, further increasing their revenue.
Plus, acquiring another business can mean gaining access to their existing customers.
What are Possible Impacts of a Business Acquisition?
It’s worth noting that, like any other business strategy, business acquisitions do not guarantee success.
To be successful, you have to plan each step carefully as it can have long-term impacts on both the target and acquiring company, which may or may not be favorable.
We’ve outlined some possible business acquisition impacts for you below:
1. Change in Capital Structure
One of the effects of a business acquisitions on both target and acquiring companies is a change in the capital structure.
In business acquisitions, the acquiring company may pay the full price of the target company in an all-cash deal, or partly in cash, and the remaining in its own stock.
In the case of an all-cash deal, the target company has the opportunity to withdraw a significant sum of cash. If the acquiring company pays with its stock, the target company gets a share of the acquirer’s company.
For the acquiring company, paying in all-cash may deplete their cash reserves.
However, since companies often can’t devote a significant sum for the investment, most of them usually apply for financing for additional funding. Naturally, this will increase the debt-to-income ratio of the company.
However, the additional debt can be justified by the additional cash flow stream from the target company.
Moreover, if the acquirer decides to buy using its own stocks, the target company’s management should be able to convince the shareholders that accepting stocks as payment is a good idea. Support is often easier to obtain if the acquiring company is a Fortune 500 company.
2. Perception of the Market Participants or Market Reaction
Additionally, the acquisition’s success may also depend on the market participants’ reaction to the deal. In some cases, the target company’s stock prices may increase or exceed that of the offer as the acquisition is made public.
This happens if the acquiring company has low-balled their offer or the target company’s stocks are so valuable enough that it attracts a rival bid.
However, the stock prices can also plummet if the acquirer’s share is involved in the deal and the acquirer’s stock prices drop as they announce the acquisition.
This can happen for a variety of reasons.
For one, the market participants may think that the purchase price is too high. Additionally, the shareholders may believe that the company is taking on too much debt in funding the business acquisition.
The Bottom Line
A business acquisition can be a profitable business venture that can foster rapid growth for the acquiring company.
However, like other business strategies, business acquisitions require careful planning and cautious implementation.
You should understand the risks so that you can plan your way around them. If you do it right, you’ll be able to take leaps towards success and eventually see your business slowly take over the industry.