M&A synergies and impact on business valuation

The value of a business can be calculated through a number of methodologies; however, only by assessing potential synergies is when a buyer will understand the true impact of a potential transaction.

What are synergies?

Synergies are achieved when the value of the whole exceeds the value of the sum of its parts.  In other words, when 2+2 equals more than 4.

Synergies in M&A (mergers and acquisitions) are achieved when the integration of a business acquisitions into an existing business or organization creates value beyond what each business produced by itself.

An example of synergies is a business that mainly delivers equipment installs, which buys a business that mainly offers equipment service.  The combined entity that delivers installations and can now service their installations can cater to customers who only work with vertically-integrated companies, thus increasing their target market.

Types of synergies

There are several types of synergies in M&A:

1. Operations. 
   There occur when the operations team from one organization complements the other’s.  In the example above a team that is strong in construction complements a team that is strong in service.
   
   
2. Administrative. 
   These are realized when the administrative team of one company brings talent and/or resources that the other company did not have, or previously procured from third parties.
   
   
3. Sales and marketing. 
   This is very frequently achieved when companies cross-pollinate customer lists; in addition, they exchange techniques and methods that make stronger the overall organization.
   
   
4. Intellectual property. 
   This is particularly relevant in technology companies and manufacturing, where the intellectual property can complement a product line making it more attractive to the customer base. 
   
   Another dimension occurs when a product from one company is dramatically improved by leveraging technology from another company.  This as an example was experienced when Confinity (aka Paypal) merged with X.com.  One company leveraged the technology of the other, making the resulting company a stronger business (now known as Paypal).
   
   
5. Value chain. 
   Considering value chain as all the elements from raw material to product/service delivery, synergies can be achieved anywhere from better procurement processes, better distribution techniques, warehousing and inventory management, all the way to customer service.

M&A can also result in cost savings that are often referred to as synergies, these include:

1. Direct and indirect labor. 
   Since both companies already have a leadership team, management team, and execution team (operations), merging both organizations allow the new leadership to restructure (reduce) some of the members of these groups and realize economic savings.
   
   
2. SG&A.
   Similar to Direct and indirect labor, the sales and administrative teams from two integrated companies will partially be duplicated, rendering the opportunity to restructure full-time-equivalents (FTEs) and realize savings.
   
   
3. Procurement.
   Savings are realized when the resulting company of an integration leverages the purchasing power of the combined entity, and/or leverages the best agreements from the two.  This is particularly true for the indirect procurement expenses such as telecommunication, information technology, logistics, warehousing, transportation and shipping, among others.
   

There are quantitative methods to calculate these synergies.  When a business explores the acquisition of a target, understanding the synergies can make a difference between securing the business by presenting a strong, competitive offer, or losing it to another prospective buyer that better estimated the synergy value of the acquisition target.

If you would like to evaluate a potential acquisition transaction and/or estimating acquisition synergies contact us today to schedule an informational consultation.