The Company Act 2013, has prescribed several methods to raise the capital of a company, which include right issue of shares, employee stock ownership plan (ESOP), preferential allotment, sweat equity...
With the rise in global competition, companies engage in more M&A transactions to attain top-line growth and increase shareholder value. Businesses tend to explore new avenues for sustainable success. Leading organizations are on constant pursuits to gain competitive edge, thus emphasizes on cost synergies, consolidation of resources, value creation through Mergers and Acquisitions. Though capturing the value in an adequate source that helps to ascertain long-term profits, yet executives often find it challenging to create value in M&A transactions. Further, it results in failure to produce the projected financial numbers and synergies. This write-up highlights the challenges in creating the value of M&A transactions.
What does it mean by Value Creation?
The preliminary objective of setting up a business is to create value. Value creation can have variant meanings for shareholders, owners or stakeholders. An owner may seek to create value for himself during the inception stage of his business by generating returns that not only surpass his capital costs, but also meet his target return on investment. As the business prospers, the company also needs to consider the expectations of other stakeholders for value creation. Strategically, the company strives to meet its customers’ value expectations, hence accomplishes higher sales of its goods & services.
For instance, in an upcoming technology-driven venture like robotics, the value creation can be obtained by investing in research & development, focusing on innovation or merging with existing technology firms. Such strategies enable businesses to provide their customers with the latest products having a myriad of advanced features.
In other sectors like retail, customers seek consistent quality products, innovative processes, and an enhanced ‘brand experience.’ Hence, the company’s value can be driven by factors like market presence, revenue growth, brand strength, productivity, and stability of margins. In operational terms, the business also needs to meet stakeholder expectations, employees concerns, regulators, and society at large. By creating value, the company deploys its financial and human capital in a more efficient manner, thus, achieves profitable and sustainable growth.
Though Mergers and Acquisitions are a robust tool in a CEO’s strategic toolkit, yet value creation through mergers and acquisitions still remains a mirage.
Primary Reasons for failure in value creation through M&A
Indian companies would have been in a better state if they had not taken the path of Merger and Acquisition for organic-growth. Around 75% of M&A transactions made by the local firms have failed to create substantial value from the deals; moreover, 59% of the acquirers have indeed destroyed value within one year of closing the deal.
As per the legal experts, the Indian companies do not accentuate on integration issues before finalizing an M&A deal. However, the acquirers around the world persistently insist on an integration plan and a detailed synergy assessment prior to sealing the deal. Besides, firms lose interest in the acquired assets and do not refurbish them post-transaction, which affects the value of the acquirer.
Generally, it takes 12 months after M&A deal completion to determine the success of the transaction and check if it will add any value for the buyer’s shareholders or not. The most common reasons that lead to the failure in value creation through mergers and acquisitions are cultural disparity and post-integration while there are other factors as well. Let us look at the other reasons:
- Inadequate Involvement of the Owner- Some business leaders may take an active part in the process of Merger and Acquisition, but plenty of the owners count on experts to handle most of the work. During the negotiations of M&A transactions, many professionals oversee the major issues. It creates problems for the business owners to smoothly function as they do not get an insight into the existing circumstances and expectations post-transaction for being out of the picture.
- Integration Impediments- Merger and Acquisition is far easier on papers than merging the operation & culture in actual. Things may get topsy-turvy if there is no concrete plan for the integration. Also, a company faces integration obstacles due to miscommunication amongst the middle to higher management. An uncertainty Merger or Acquisition disrupts the company’s productivity and efficiency. Therefore, such the integration must be evaluated beforehand and handled diligently.
- Inaccurate Data and Valuation Errors- Overly strategical evaluation and lofty projections are common reasons for the deal’s demise. Granted, the parties do everything possible to do an approaching deal. Regrettably, this often shows that the financial matters are certainly calculated and analyzed rather “innovative” to make them as attractive as possible. Although it is evident that the parties seek to anticipate the numbers assuming the best case scenario, however, the reality is far below than what was presented prior to the deal.
- Resource Limitation- A newly formed entity requires plenty of resources, both financial and human, to overcome the challenges of integrating two different cultures and companies after M&A. The company ought to update policies, invest in creating extra real estate space, which requires a bit of time and money. Thence, the company must consider and plan beforehand; however, that is not always the case.
- Unfavorable Economic Factors- Even the best business plans can go wrong if there is a sudden change in the economy, which affects stock prices and interest rates. A negative economic climate will certainly hinder the success of a Merger and Acquisitions, regardless of how well they were expected to perform.
- Lack of Strategy and Planning- Mostly, the issues mentioned above are responsible for an M&A deal’s failure, but that can be avoided with proper planning, creation and execution of a coherent strategy. The central focus is on getting the M&A deal closed, but not enough attention is paid on the aftermath. Such lack of foresight is the reason that even the smallest issues get in the way of the deal’s true potential.
Efficient ways for Successful Value Creation through Mergers and Acquisitions
Around 34% of acquirers’ claim that value creation is a priority on the day of closing the deal, however, 66% of dealmakers said that value creation must be a priority right from the start. Some acquirers only emphasize upon integrating the hard tangible assets such as accounting, financial, and operations systems, during M&A to achieve the desired value. Besides, they neglect the soft and equally important intangible assets like people and culture. The root cause of failure in value creation through Mergers and Acquisitions is the acquirers’ inability to create synergy, selecting inappropriate target companies, paying too high a premium, and ineffective integration.
Things to consider for successfully creating value through M&A:
- With a wise selection of targets and effective implementation of acquisitions, one can achieve synergy and create value. The difference in the sizes of an acquiring company and the target company affects value creation. In case the target company is much smaller than the acquiring company, then it shall not affect value creation. On the other hand, if the target company has same capabilities as an acquiring company, an opportunity for synergy creation exists. If the difference narrows and value creation increases, integration often becomes a problem. It further leads to value loss, even if the companies involved are of similar size.
- The acquirers need to stay true to the strategic intent. Companies must approach Merger and Acquisition deals as part of a clear strategic vision and align it to the long-term objectives for the business. 86% of acquirers said that their latest acquisitions had created a significant value as it was a part of a broader portfolio review than merely an opportunity. Thus, companies must bring a more strategic lens to M&A planning and understand where the business requires strengthening.
- Companies must have a clear blueprint containing all the elements of the value creation plan. Acquirers should ensure to conduct a thorough due diligence across all areas of the business for a successful value creation through Mergers and Acquisitions. Consider some factors like how each element of the value creation process supports your business model, operating model, technology plans and synergy delivery. Reportedly, 79% of acquirers did not have an integration strategy in place when signing an M&A deal, while 63% did not have a technology plan.
- Lastly, prioritize and fix cultural differences at the start of a deal. Human capital and talent management majorly influence how companies can deliver value. 82% of companies said a large value was destroyed in their latest acquisition and lost more than 10% of employees after the transaction took place. Businesses should invest more time and resources in the process of M&A transactions to succeed. Over two-thirds of the companies said that their latest M&A deal subsequently created a significant value as they had an integration strategy in place while signing. The acquirer must have an ability to bring different cultures together, which is a key factor in determine the success and failure of the deal.
A successful M&A process utilises these best practices:
- Thorough evaluation and due diligence of the target companies
- Strategic interest of the potential synergies
- Resource and cultural management;
- Solid communication strategy which helps to facilitate a change in management and raise value creation.
The concept of value creation through mergers and acquisitions depends on how you manage the process from merger preparation to post-merger integration. The process includes thorough assessment of whether a deal is worth pursuing or not, robust strategy and M&A methodology. Acquirers must have their value creation plan together in place prior to indulging in a deal and cultural issue which might hamper the actual value in their long-term strategy.
Any company that strives to create value through M&A must take professional assistance from Swarit Advisors. Being legal experts in Merger, Acquisition and due diligence, we can help you create an accurate value for your business. It shall not only be idealistic but also achievable.
Also, Read: Analysis of Merger and Acquisition.