Horizontal, Vertical and Circular Mergers

From a legal point of view, a merger is the legal consolidation of two companies into one entity,  whereas an acquisition occurs when one company takes over another and completely establishes itself as the new owner.

In management practice the distinction between a merger and an acquisition has become increasingly 'blurred' in several respects.

What types of mergers can be distinguished?

• Horizontal merger: involves firms performing the same activities/functions in the same supply chain. Both firms are in the same line of business. By buying the competitor, the acquiring company is reducing the competition in the marketplace.
• Vertical merger: involves firms performing different activities/functions in the same supply chain. The acquiring firm buys buyers or sellers of goods and services to the company.
• Circular merger: involves firms with different products but similar distribution channels. It is a transaction to combine 2 or more companies operating within the same market, but offering a different product mix. The aim is to increase the product and service offerings within the target market.

Reasons Why Mergers Fail | M&A Failure Reasons

A merger can be defined as the union of two or more organizations under single ownership through the acquisition by one organization of the assets or liabilities of the other.
Even if mergers and acquisitions can be an excellent way of increasing and protecting marketshare, this strategic approach does not always deliver what is hoped for in terms of increased profitability or economies of scale.
Typically mergers and acquisitions aim for synergy. But merely recognizing potential synergy areas does not guarantee that they will actually be realized by combining two firms.
Typical reasons for merger failure include:
- Viewing M&A only as a financial, strategic activity, ignoring soft issues such as people, resistance to change and company cultures. When left completely unattended, this may lead to acts of sabotage and petty theft, increased stuff turnover rates, and increased absenteeism and sickness rates. But any merger team is likely to face difficulties of merging the two company cultures, departure of key people and demotivation of remaining employees.
- Spending too much energy and time on dealmaking instead of post-merger planning.
- Payment of an overinflated price for acquired company.
- Poor strategic fit.
- Failure to achieve potential economies of scale due to poor management.
- Unpredicted changes in the external environment.
Without proper preparation, in particular post merger integration planning, mergers will not achieve their true potential.

6 Myths on Venture Capitalists

An article worthwhile reading for both entrepreneurs, venture capitalists (VCs) and corporate finance specialists is "6 Myths about Venture Capitalists" by Diane Mulcahy (HBR, May 2013). According to Ms. Mulcahy, a former VC and now director of private equity at the Ewing Marion Kaufman Foundation, entrepreneurs often feel "as if they are in the back seat" when dealing with VCs. This is caused by a number of misconceptions or myths about VCs and what they are offering:

1. Venture Capital is the Primary Source of Start-up Funding - In reality, especially for smaller new businesses, 'angel investors' (affluent individuals who invest smaller amounts of capital in earlier stages, for example see Angelist) funds more than 16 times as many companies as VCs do. Also 'crowdfunding' (very small online investors, for example see kickstarter) is growing quickly.
2. VCs Take a Big Risk When They Invest in Your Start-up - In reality, they do take a lot of risk, but not with their own capital, but with capital they received from associated investors. On thus committed capital, VCs typically charge an annual 2% fee, plus a success bonus.
3. Most VCs Offer Great Advice and Mentoring - In reality the level and quality of advice given varies tremendously. Entrepreneurs are well-advised to do some thorough due diligence before they sign up.
4. VCs Generate Spectacular Returns - Some do, some don't. Overall as a group they don't perform better than the markets.
5. In VC, Bigger is Better - In reality, the smaller funds tend to outperform the bigger ones.
6. VCs are Innovators - The VC industry has not been very innovative over the last decades, new initiatives such as mentioned Angelist came from outsiders.

The Optimal Acquisition Integration Approach?

In case of a merger or acquisition, what is the optimal integration approach? Actually there are 4 possibilities:
# Resource sharing. Value is created by combining the companies at the operating level.
# Functional skills transfer. Value is created by moving certain people or sharing information, knowledge and know-how.
# Transfer of general management skills. Value is created through improved insight, coordination or control.
# Combination benefits.
Source: Acquisition Integration Approaches.

Balance Sheet Method

When a business buyer and seller come to the table, the often tough question of how much is a business worth must be answered. There are many valuation methods that are used, some very simple to understand and some very complex often involving higher level differential math. In most cases, parties are more happy with simpler methods that are easy to conceptually grasp. Here I will show you the most simple method of valuating a business, the Balance Sheet Method. In the balance sheet method, one only looks at the business's assets and liabilities to determine exactly how much it is worth. Let's take a look at a quick simple example. ABC Corporation has this balance sheet: Assets Liabilities Cash $100,000 Accounts Pay. $50,000 Factory $1 million Mortgage $500,000 In this example, there are $1.1 million in assets and $0.55 million in liabilities. The business is therefore worth $0.55 million, or $550,000. If you are familiar with GAAP, the body of general accounting standards, assets are carried at book value, which is often much less than market value especially for appreciating assets like real estate. Many will therefore use the Adjusted Balance method which takes into account the market value of assets. Let's say we reconsider the above example, and we see that ABC bought the factory 10 years ago. The industrial real estate in its market has appreciated so now the factory would sell for $1.5 million today. Now the worth of the business is $1.05 million instead of $0.55 million. Whether one uses the balance sheet method or more popular adjusted method, the approach is looking at what the business is worth based off its asset alone. It takes nothing into account of how much a business has in earning power. The balance sheet method lets one take the perspective of "I walked away from this business tomorrow, sold everything that it owns, how much do I get?"

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Increasing Board of Directors M&A Responsibilities

According to Ian Cookson (Corporate Finance Director at Grant Thornton LLR), as a result of recent higher levels of governance, both in the courts and by new legislation such as The Sarbanes-Oxley Act of 2002, directors are likely to become increasingly involved in acquisitions, including evaluating transaction strategy and post-acquisition integration plans.

Cookson (iancookson@gt.com) recommends the following useful shopping list in the "Financial Excutive" of Oct2004 for Key Responsibilities of the Board of Directors during an M&A:

1. What are the integration plans?
   (Short-term actions, Communication plans (immediate and ongoing), Synergy delivery plans (and likelihood they will be
   achieved), Internal controls compliance plan, Individuals accountable)
2. Is the strategic rational robust?
   (Closeness of fit with existing business, Acquisition's ability to leverage strengths and resolve weaknesses, Do economic realities match the story?, Other targets/options explored)
3. How will we manage implications of people and culture?
   (Closeness of cultural fit, Implications for future ways of working, Retention and rewards for key people, What is it that makes the business successful?, How this wilt be retained and built on?)
4. Viewing risks (in above) in context of price
   (Valuation, comparables, financing structure, Fairness opinion is independent, Due diligence is robust and directed to uncovering potential liabilities)
5. Board litigation protection
   (Process, deliberations and analysis documented, Use of independent experts)
6. Value added by board members
   (From personal experiences, Not simply monitoring management, Balanced perspective on weighing risks and rewards)

It is expected from board members to add considerable value to the above areas and to bring additional perspective to balancing the risks and benefits of the acquisition. If you're in an M&A trajectory right now as a Director and you're starting to feel a little bit uncomfortable: don't worry: Mr. Cookson expects an expanded role of independent advisors to the board likely to follow suit, moving well beyond fairness opinions into the above areas ;-)

M&A lessons for boards

I just finished reading a superb new book on value based management called "Questions on Value". One of the 11 papers in the book I liked most is about "Achieving valuable growth through M&A - Boardroom lessons for the acquisition game".

This article is a contribution of Mark L. Sirowe, Global Leader of the Mergers and Acquisitions practice of Boston Consulting Group and Professor at Stern University (New York).

It shows Mr. Sirowe is both a seasoned M&A consultant and an excellent lecturer. The article reads indeed like very good lessons at boardroom level on:
- how companies can establish strategic M&A processes and become an "always on company" as Sirowe calls it, and
- what boardrooms should go through on proposed deals.

To give you just a taste of the article, as a final M&A racing diagnostic Sirowe recommends boards to ask/think over the folowing questions:

• Is there evidence this deal emerged from a clear strategic perspective?
• How is this deal consistent with our long-term objectives for customers, markets and products/technologies?
• What are then stand-alone expectations of acquirer and target?
• Where will performance gains emerge as a result of the merger?
• Are the projected performance gains in line with the premium being paid?
• Which competitors are likely to be affected by the deal and how will they respond?
• What are the milestones in a 12-24 month implementation plan?
• What added investments will be required to support the plan?
• Who are the key managers responsible for implementing the plan?
• Which pieces of either company are good candidates for sell-off or split-off?
• Why is this deal better than alternative investments?

Kudos to Mr. Sirowe for this article.