The Fundamentals of Mergers and Acquisitions

If your company is struggling with its profitability and battling to compete, the idea of expanding through a merger or acquisition may seem ridiculous. But that doesn’t mean there isn’t a larger business out there that may want to add your organization to its roster as part of a greater strategic plan.

Or maybe you’ve emerged as the leader of the pack in your market, and gobbling up a suitable company at an advantageous price could further cement your dominance. Whatever the case may be, it behooves every savvy business owner to stay up on the fundamentals of M&A — just in case it happens to you.

Beyond retirement

Perhaps the first thing to cross any business owner’s mind when the prospect of an M&A deal comes up is: Should I do this now? Whether you’re a seller or a buyer, timing is everything.

So, as a seller, when is the right time? Well, retirement is the most obvious example. If you plan to, at least in part, live off the proceeds of the sale of your business after you retire, you’ll need to start hunting for the right M&A deal well in advance of your bon voyage party.

Yet don’t assume the perfect buyer will emerge right when you’re ready to hang it up. You may find the ideal candidate a few years before your planned retirement date. In that case, you’ll have to make the tough call as to whether to retire early or risk losing your suitor. On the bright side, in many cases former owners can stay involved with the company as a consultant.

Of course, even when an owner hasn’t been planning to sell the business anytime soon, an urgent need to sell can come up — especially these days. Shifting market conditions, obsolete product lines, outmoded technologies and lack of credit may be signals that it’s time to move on.

Leadership conflicts can also be a glaring red flag. Do you spend more time fighting than working with your business partner? If so, a sale could be an extreme but necessary solution.

Opportunity + capital

For buyers, timing is somewhat simpler. It’s generally a matter of opportunity plus capital. That is, you encounter a suitable target to merge with or acquire and you have the finances to get the deal done. But that doesn’t mean it will always or even usually be an easy decision.

An M&A target must fit in with your strategic goals. You’ll be spending a lot of time, money and resources on a deal. And, once it’s completed, there will still be much work to do. So you’ve got to ensure that the business you’re buying will make you more competitive and profitable, not just briefly put your name in the news.

Due diligence is of paramount importance. That means not only fully grasping the target’s finances and any legal issues involved, but also looking closely at the target’s operations. Scrutinize its marketing and sales, production, and administration departments carefully. These functions can often hold deal-breaking pitfalls.

Taxes and sale structure

As you might expect, Uncle Sam will want a piece of any M&A transaction. But not every business sale need be immediately taxable. Some arrangements may qualify for tax-deferred treatment. Examples include transactions in which the seller receives buyer stock or certain qualifying property in exchange for their stock or assets. Corporate or partnership/limited liability company (LLC) mergers may be eligible for tax deferrals as well.

Understandably enough, many parties to M&A deals favor the idea of a tax-deferred sale. But there are situations in which paying taxes upfront is the better way to go. For example, despite immediate taxability, cash-only sales are simpler and typically quicker to execute. Buyers typically favor a taxable sale to get a stepped-up basis in the assets, which can reduce future taxes.

If your company or one you’re thinking about buying is structured as a corporation, you’ll have to choose between a stock sale and an asset sale. Parties to an M&A deal often end up at odds here: Sellers look to stock sales to get favorable capital gains treatment. Meanwhile, buyers prefer asset sales to maximize future depreciation write-offs and to limit legal liability. (The buyer assumes the known and unknown liabilities in a typical stock deal.)

Buyers also tend to frown on stock sales because they’ll have to deal with the carryover basis in the assets, which may raise their future tax liability. Conversely, stock sales of C corporations appeal greatly to sellers because the departing owner(s) may avoid double taxation when they sell the assets and then distribute cash to shareholders.

Deal ready

The uncertain economy has put a dent in the frequency of M&A deals. But plenty are still going down and much depends on the industry in question. Even if a business sale or purchase is the furthest thing from your mind at the moment, keeping your company in “deal ready” shape can strengthen your leverage should an intriguing opportunity arise.

Don’t forget about an integration plan

In any merger or acquisition, a large amount of work goes into establishing a sales price, doing the due diligence, making sure all the required legalities are in place and working out the terms for precisely how the money will change hands.

But let’s say money matters are settled and a deal is in place. What then do buyers and sellers have to think about? In a word, integration. Whether one organization is consuming the other, or the two are merging together, how will they execute that union smoothly?

Granted, a seller could just wash his or her hands of the matter and let the buyer worry about it. But most departing business owners want to know that their employees will be in good hands and operations will move forward positively and productively.

To this end, an integration plan should be part and parcel of any M&A arrangement. And this plan needs to set the right tempo for the transition. Sometimes a buyer will finish the sale and immediately start shutting down divisions and laying off workers. As a result, remaining staff feel alienated and even angry, which hurts morale and productivity.

Then again, an integration that moves too slowly can leave workers confused and even frustrated. They might ask: “Where’s the win-win we were promised? None of our problems are being solved!” The company may also start to bleed cash if the transition goes too slowly and redundancies get the better of the bottom line.

In M&A deals, timing is indeed everything. But so is tempo — the transition must move at the right pace. A carefully constructed integration plan can ensure this happens.

Please contact Feeley & Driscoll's Boston Accounting and Consulting Firm by Email or call 1 (888) 875-9770 if you have any questions.

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