Expanding a business beyond borders can take more than a hefty bank loan and a good export plan. For an increasing number of medium-sized businesses, joining forces with another company can extend their global reach and open doors to bigger and better opportunities.
This strategy is known as mergers and acquisitions (M&A), a process that involves combining two companies into one: Either one company buys another company outright (acquisition) or two companies come together to create a new business (merger).
Neither option leads to overnight success: There are several important steps to the process, including due diligence, negotiation of terms, and integration of the acquired company into the target company’s operations.
“M&A can be a strategic move for companies looking to expand their market share, diversify their products or services, access technology, or achieve economies of scale,” says Guillermo Freire, Export Development Canada’s (EDC) senior vice-president, Mid-Market Group.
“While it can be a complex and challenging process, it also offers significant benefits for companies looking to grow and achieve their strategic goals,” Freire says.
Today, in the first of two blogs, Karen Hennessey, partner of the business law group, Gowling WLG, and Mike Reid, EDC senior financing manager, Mid-Market Lending Investments, answer key questions about M&A and what it takes to achieve success.
The words merger and acquisition can be confusing. Isn’t it just an acquisition?
Hennessey: In practice, the distinction between a merger and acquisition can be blurred, and the two terms are often used interchangeably to describe any transaction in which one company assumes control over another.
But a merger is a legal process by which two or more companies combine into a single entity. The companies involved often create a new legal entity that absorbs the assets, liabilities, and operations of the original companies.
An acquisition refers to one company purchasing the assets or shares of another company. In this case, the purchasing company assumes control of the target company’s assets, operations and liabilities, or in a share deal, the target would become a subsidiary of the purchasing entity.
Reid: In an acquisition, the sellers either leave the business on closing or only stay on for a defined period of time to ensure a smooth transition. In a merge, quite often, owners of both companies stay on, and operations are merged and made efficient.
What’s the difference between a share purchase and asset purchase?
Hennessey: In M&A, there are two main ways in which the sale of a business can be structured: Share purchase and asset purchase.
In a share purchase, the buyer acquires the shares of the target company directly from its shareholders. The buyer becomes the new owner of the target company, including all of its assets and liabilities. This means, the buyer assumes all of the risks and rewards of the target company’s existing business.
In an asset purchase, the buyer acquires specific assets of the target company, rather than the entire company. The buyer selects which assets they want to acquire and negotiates a purchase price for those assets. This means, the buyer can avoid assuming any of the target company’s existing liabilities unless they’re specifically transferred as part of the asset purchase.
Reid: With a share purchase, you’re buying up to 100% of the issued and outstanding shares of the company. It’s usually more beneficial for the seller to have a share purchase. With a share purchase, you’re effectively transferring all the assets and liabilities of a company to the purchaser, so it’s inherently riskier for the buyer. In an asset purchase, you’re simply buying the assets of the company and as the buyer, you’re effectively sheltered from any unforeseen liabilities.
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Who drives the acquisition—buyer or seller—and in which jurisdiction?
Hennessey: Both the buyer and seller play important roles in the acquisition contract, as it’s a negotiated agreement between the two parties. The buyer typically drafts the initial contract, which outlines the terms of the proposed acquisition, and then the seller will review, negotiate, and potentially revise the contract to ensure it’s in their best interests.
As for jurisdiction, if you mean deciding which jurisdiction and governing law to include in the acquisition contract, then in that case, both parties will need to consider a number of factors such as the location of the parties and target company, and the legal and regulatory requirements of the relevant jurisdictions. In many cases, the parties will agree to the laws of the jurisdiction in which the target company is located, as well as to the jurisdiction of the courts in that location to simplify legal proceedings and reduce the potential for legal conflicts.
Is it easy to acquire just the intellectual property (IP) of a global business rather than the entire business?
Hennessey: Acquiring only the IP may be easier and less expensive, as there may be fewer assets to transfer and fewer legal and regulatory hurdles to navigate. But if the IP is tied to specific employees or processes critical to the success of the business, it may be difficult to separate the IP from the rest of the business.
The value of the IP may also be difficult to determine, and there may be legal and regulatory requirements for transferring the IP that can make the process more complex. The ease or difficulty of acquiring IP versus the entire business will depend on the specific circumstances of the transaction, including the nature of the IP, its value to the business, and the legal and regulatory requirements for transferring the IP.
Reid: If the IP of a company is its most valuable asset, then the sale will involve the whole business. I’m not aware of any business that’s willing to sell its IP without selling the entire company.
Is it better to buy an existing company or start your own, in terms of cost, knowledge and time?
Hennessey: It depends on your business strategy, goals and objectives:
- Are you looking to diversify, i.e., do you want to position the company in higher-growth markets or products? If so, then opening a new office or branch in the desired market may be worthwhile.
- Are you looking to acquire capabilities to enable you to adjust to environmental changes—technological, regulatory, or even political change—more quickly than you could if you developed them internally? If so, then organic growth will likely be more challenging and an acquisition may be the best option.
- Are you looking to develop operating synergies following the acquisition? If so, then an acquisition likely makes sense because it will allow you to improve operating efficiency through economies of scale or scope by acquiring a customer, supplier, or competitor, or enhance technical or innovative skills.
- Is the target market highly competitive or already saturated? If so, starting a new business from scratch may be more difficult. If there’s significant potential for growth, buying an existing company may be a more attractive option.
- Finally, evaluate/assess your resources, including your time, money, and expertise. Starting a new business from scratch may require more time and financial resources in the long term, in order to develop a new product, hire specialized staff and build a customer base. On the other hand, buying an existing company may require less time, but likely has larger upfront costs (i.e. the purchase price). In either case, you’ll need strong financial and management expertise to successfully manage and grow the business.
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Is it a good idea for a startup to acquire a business to avoid the challenges of organic growth?
Hennessy: Acquiring an existing business can have several advantages for a startup, including access to an established customer base, a proven business model, valuable intellectual property, and experienced staff. But there are also potential disadvantages such as the high cost of acquisition, the challenge of integrating the two businesses, the loss of control for the startup, and the risks associated with acquiring an existing business, including hidden liabilities or outdated technology. It’s important to carefully weigh the pros and cons and conduct thorough due diligence before making a decision.
Top 3 reasons M&As fail?
Hennessey: Mergers and acquisitions can be complex and risky, and there are many reasons why they fail:
- Cultural integration issues: M&A deals often fail because of differences in corporate cultures and values between the two companies. If the cultures clash, it can lead to communication breakdowns, low morale, and the loss of key employees. It’s important to assess the cultural fit of the two companies before embarking on an M&A deal and to put in place strategies to manage cultural differences.
- Overvaluation: Overvaluing a company can lead to unrealistic expectations and an inability to achieve the desired outcomes. If the price paid for the target company is too high, it can result in a lack of synergy and an inability to achieve the expected cost savings or revenue growth. It’s important to conduct thorough due diligence and have a clear understanding of the target company’s financials and market potential.
- Poor integration planning and execution: The success of an M&A deal depends on how well the two companies are integrated after the closing. If integration planning is poor or execution is flawed, it can result in operational issues, lost customers, and low employee morale. It’s important to have a detailed integration plan in place before the deal closes and a dedicated team responsible for managing the integration process.
Part 2 of 2 in series