A big question for any business is ‘How can we grow?’ In this series of articles, Buckles’ Company Commercial lawyer, Tom Birkett, takes a look at how businesses can grow through a merger or acquisition. Here, Tom examines the issues involved in merging with another company.
Creating an effective structure, in terms of scale and ownership, is a key element of the strategic management of a business. Mergers and acquisitions (more about those next week) are the two main options for driving change in this regard.
A merger takes place when two or more entities join together, sharing the risks and rewards of the combined entity. This article examines the key advantages and disadvantages of mergers.
Benefits of Mergers
If a merger is managed successfully, the benefits can be extensive.
Where two entities combine their operations, any resulting increase in output can help to reduce average costs and increase economies of scale. In addition, a larger company can potentially obtain a lower rate of interest from a lender, and more substantial discounts for bulk buying.
Whilst the merger may involve a transition period and temporary job losses in the short-term, overall productivity and efficiency should increase within the merged entity.
Entities can merge within, or between, industry sectors. This increased scope and diversification can help entities to remain competitive, and potentially enable increased rates of growth.
In addition, improved profitability in the new firm can enable greater investment – including in riskier projects, thereby allowing for greater innovation without increasing financial risk.
Finally, by merging with an overseas entity, a company can increase its geographic reach, thereby competing more effectively against multinational rivals.
Ultimately, a strong merger can create a new firm that is greater than the sum of its parts, in terms of its operations and its brand profile. However, as set out below, this is subject to certain risks and practicalities, which should be considered as early as possible within any potential merger.
Risks and Practicalities of Mergers
For a merger to succeed, it is vital to assess the strengths and weaknesses of the other party by conducting a due diligence process. Advice should be taken from solicitors and accountants accordingly. A further issue, particularly for smaller businesses, is the potential cost – both financially and in terms of management time – of conducting due diligence.
During merger negotiations, a large amount of information about a company is shared with the other party. Accordingly, it is important to get advice at an early stage on using mutual non-disclosure agreements or confidentiality agreements between the parties. Taking this step will help to ensure that information is kept confidential, particularly if the proposed merger falls through.
Mergers are subject to the UK merger control regime. Merger control applies to transactions which are caught by the legislative ‘share of supply’ test. Pertinently, the ‘share of supply’ test is particularly widely-drawn, and is therefore something of which parties to a merger should be aware. If caught by the test, a transaction may be reviewed by the Competition & Markets Authority.
Depending on the specific circumstances of your business, there are various options available for structuring a merger, so it is important to obtain professional advice. In addition, both sides need to be mindful of how the merged company will operate. To this end, the parties may wish to draft a Heads of Terms document, setting out the practicalities of the merged entity, and ensuring that the proposed structure is tax efficient.
In seeking to merge, an entity might compromise too much on an element of its operations or identity, and jeopardise the future success of the merged entity. Conversely, however, it may be that individuals within an entity are overly attached to the identity of their firm.
It is important for a leadership team to actively and effectively manage the merger, and for post-deal integration to be prioritised. If not, potential efficiencies may not be realised, and differences in organisational culture may endure. Moreover, in managing the merger, it is important to consider the views of all staff and to ensure that individuals feel invested in the merged entity. Otherwise, when roles and organisational structures are subsequently being finalised within the merged entity, unhappy staff may choose to leave.
Finally, it is vital to ensure that a clear brand strategy is devised and maintained. The merged entity should have a unified and effective brand profile which builds upon the strengths of the constituent entities, and is also forward-looking and distinctive.
Conclusion
In seeking to grow or change the ownership of a business, those involved need firstly to clarify their objectives, and the facts involved. Having done so, the parties then need to consider how they can best meet their objectives, including via the options outlined above.
This is not legal advice; it is intended to provide information of general interest about current legal issues.
