Steve Faulkner, Head of Private Business Advisory
Andrew Oshman, Private Business Advisory
Zachary Hammond, Private Business Advisory
Ajit George, Private Business Advisory
Business owners are increasingly considering their timelines and options for a business transition. Consistent with prior years, that transition event is frequently a sale due to supply and demand factors.
The majority of businesses are owned by baby boomers who are rapidly approaching the age of retirement. A financial crisis and pandemic in the last 15 years have taken their toll.
On the demand side, record levels of cash on corporate balance sheets and the unprecedented amount of debt and equity capital needing to be invested have resulted in an attractive environment for many businesses in which to evaluate their alternatives.
If you’re thinking of selling your business—either now or in the future—be prepared to show buyers the synergistic fit with your company. Make it clear that there is more to offer than the expense reductions achieved by running two businesses as one.
It will further help you to make your case by understanding how the current environment is dramatically changing market conditions—forcing many buyers to search for ways to improve the sustainability of their business models and overcome new disruptions, whether in the form of new technology, competition or other forces.
Carefully position your sale with these factors in mind—or risk leaving value on the deal table.
The synergies challenge
Often, if M&A synergies are negotiated, the focus is on cost synergies: how the sale will save money/reduce operating expenses for the new entity. The value of revenue synergies usually doesn’t get structured into the deal price. Here’s why:
- Cost synergies, such as reducing headcount or eliminating duplicate facilities, are easier to anticipate and quantify. Such actions are also within management’s control, so there’s a greater probability of achieving results, and in a shorter timeframe after the deal closes. This is especially true when the buyer is publicly traded and must justify the value of a merger or acquisition to shareholders. To calculate future financial performance (i.e., the run rate), companies typically project the value of expense-saving synergies and give less attention to those that build sales or enhance market position.
- Revenue synergies are more difficult to quantify, in part because success is heavily dependent on others: the buyer (i.e., post-merger integration success) and various third parties (customers, resellers, competitors). Also, the value of revenue synergies, such as entering new markets, enhancing technological capabilities and adding complementary product sets, typically takes longer to realize. And the longer it takes and the more challenging to achieve, the less likely the seller will receive a share of the potential value.
Timeline of operating synergies
The chart shows where different types of synergies fall on two spectrums: the time required to see value and the probability of success. The time required for success is shown on the y-axis, and the longer the time required is the higher up the synergy type is shown. The probability of success is shown on the x-axis, and the lower the probability of success, the further to the right the synergy type is shown.
Synergies don’t just appear
Careful analysis is required, but it’s well worth the effort. It’s incumbent upon you as a seller to:
- Analyze your company: A sell-side quality of earnings analysis performed by a third-party accounting firm, for example, can help you understand your company’s financial picture and profile, and help demonstrate the incremental value of an acquisition to potential strategic buyers.
- Understand your buyer base: Your deal’s success depends on your knowing what a potential buyer is looking for and demonstrating how your company fits within its strategy.
- Assemble your team to focus on post-merger integration (PMI), and work with a buyer to achieve PMI success before a deal closes. Keep in mind: The speed of integration is critical to successful M&A deals. Establishing an integration timeline and developing key performance indicators to monitor PMI ahead of time allow all parties to focus on these objectives on day one.
Working with your advisory team
Identifying synergies and finding buyers able to extract them are only half the battle. You will also want your advisory team to help:
- Negotiate a deal that compensates you for the value of your business’s synergies and that sets the stage for them to be realized post-transaction.
- Anticipate valuation gaps between you and the buyer. This is where earn-outs with defined, achievable metrics over a set time period after closing can be critical. Properly constructed, earn-outs provide sellers with the potential for increased proceeds, and buyers with the certainty of paying a premium for realized synergistic value.
Worth noting: Buyers received two-thirds or more of expected synergistic benefits in the immediate aftermath of the Great Recession. More recently, however, sellers have been able to capture a higher share of the total synergistic value, as synergies have become more commonplace in the case of an acquisition by buyers.
Buyers are losing ground in the battle for synergies
The chart shows the median value of synergies captured by target shareholders vs. the buyer as a percentage from 2008 through 2017. It shows that toward the end of this time frame, more of the value was being captured by the target shareholders.
Case study: How doing the homework pays off
Kathryn Joy, owner of a mid-sized U.S. manufacturer and distributor of consumer staples, believed potential synergies would make her business more attractive to select buyers, allowing for a higher sale price.
Two buyers came forward: Buyer One, a direct competitor, saw the acquisition as a way to leverage its expense structure and operational efficiency. Buyer Two, not a direct competitor, was positioned to benefit from the enhanced revenue opportunities through:
- Complementary products: Ms. Joy’s company had 10 products, most with strong sales growth potential, to complement Buyer Two’s portfolio of 100 products.
- International distribution: Buyer Two wanted to expand internationally, and a significant portion of Ms. Joy’s sales were in overseas markets.
Ms. Joy quickly realized Buyer Two saw her business as a better strategic fit than Buyer One: Buyer Two could leverage her global distribution network to quickly expand overseas and potentially minimize some of the cultural, regulatory and legislative obstacles inherent in international expansion.
As a result, Ms. Joy and her advisory team were able to negotiate a substantially higher acquisition premium than Buyer One offered to pay. In addition, she and her team negotiated an earn-out payment based on incremental international sales.
We can help
Your J.P. Morgan team can help you understand the scope of your opportunities, provide strategic advice, find specialist assistance and engage in the necessary pre-transaction planning for your company.
You’ve worked hard to make your company successful. If you’re ready to sell, make sure you get the best possible deal for the business—and for yourself.
All case studies are shown for illustrative purposes only and should not be relied upon as advice or interpreted as a recommendation. They are based on current market conditions that constitute our judgment and are subject to change. Results shown are not meant to be representative of actual results. Past performance is not a guarantee of the future performance of an investment.
