Feature
Article
Risky
Business:Mergers & Acquisitions
By Richard Millman, CPA/CFF/ABV, CVA
Mergers
and acquisitions, or M&A, can be very complex processes
that may be as risky as they may be rewarding. Differences
in internal controls, management styles, processes, data
volumes, and complexity of integrating systems between two
organizations looking to a merger or an acquisition can
often result in the increase in business risks exponentially.
Organizations that are unable to reach a consensus in these
aspects of management often fail to achieve the proposed
result of combining their business operations together.
Despite
these risks, many organizations use mergers and acquisitions
as a fast track tool for rapid expansion and growth. In
a large number of mergers and acquisitions a buyer overpays
for purchase of a business entity and the merger fails to
meet expectations. Lets have a brief look at the risks involved
and the common mistakes that happen in mergers and acquisitions.
Financial
& Business Assumptions Financial and business
assumptions form the basis of a model underlying a valuation
process and the purchase price estimated for buying an entity.
Cases where buyers forecast unrealistic synergies and economies
of scale often result in high risk and low return M&A
transactions. One common assumption that leads to wrong
and mistaken judgment is that the buyer would run the business
more effectively and efficiently than the old owner. Another
common mistake in M&A transactions is the buyers assumption
of using unrealistic and unsupported industry standards
for benchmarks. The result of this could be the buyer using
a rate of return less than the cost of his capital or purchase
cost. This, on paper, yields good returns, but in reality
would be devastating.
Incomplete
Analysis There are three approaches to valuation,
known as the cost, market, and income approaches. Often,
companies follow a rule of thumb rather than a complete
analysis for decision making. In such cases important considerations,
including those impacting non-operating assets, changes
in market dynamics, etc., are ignored.
Before
making a formal offer to merge with or acquire another business,
management must ensure that a complete analysis using all
three approaches should be performed to make best the decision
and determine a reasonable offer/purchase price.
Pricing
Multiples Issues Inflated pricing multiples are
often a major problem in the valuation exercise. Industry
wide consolidation often leads to this issue, and in certain
cases the result becomes unrealistic. Instances where companies
have paid unrealistic premiums to maintain market shares
are in plenty.
Role
of Due Diligence in Mergers & Acquisition
Due diligence is the systematic process of understanding
and evaluating a business proposition. This ideally would
cover both strategic and operational areas including operational,
financial, and technical aspects and resource related issues.
In many valuation cases, incompetent due diligence has lead
to overlooking risks, including financial related risks
such as unpaid taxes, fines, obsolete assets and organization
risks such as employee retention issues, poor management
control, etc.The result can be devastating to running the
business even resulting in bankruptcy.
Issues
that come up in the due diligence process must be carefully
understood and examined, and solutions should be identified.
The impact of due diligence may include:
a)The
potential buyer withdrawing from the deal if information
from due diligence makes the investment highly risky;
b)
Revision of the valuation of investment and adjustment
of the potential price that may be offered to the seller;
and/or
c)Resolution
of the problem and revaluation of the investment proposition.
The
best way to ensure M&A activities succeed is through
due diligence. Valuation analysts play a vital role in helping
an organization evaluate mergers & acquisitions transactions.
Thus, in reality, it is best suited for an organization
to leave the valuation process to the experts than perform
it themselves.
For
more detailed information please contact:
Richard
Millman, CPA/CFF/ABV, CVA
richard.millman@hawcpa.com
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