Most such firms are run by senior executives who have left investment banks and have considerable experience, networking contacts, and professional relationships in the financial industry. They are sometimes hired to supplement the advice of an investment bank rather than to substitute for it. Corporate advisory firms tend to be smaller, and to operate in a smaller area, than investment banks; in Europe they are in a sense the descendants of the merchant banks like Lazard and Rothschild both of which continue to offer corporate advisory services.
Valuation One of the services offered by advisory firms and investment banks, engaged when considering an acquisition, is business valuation. There are various ways to value a business, and particular methods or information may be more or less valuable in different industries.
Public companies are in general easier to value than private ones, because the law and their accountability to shareholders has required them to keep financial records that adhere to a certain standard and are audited regularly. Even well-managed private companies may not do so, particularly smaller ones.
Further, while it is in the best interest of public companies to emphasize their profits, it is in the best interest of private companies to minimize them to some degree, for the sake of taxes, and financial records will reflect this. Assets of both companies will probably have their original cost and value recorded, rather than their current market values, and valuing the company will thus require reexamining those assets.
The discounted cash flows method of business valuation values assets not according to their cost or their resale value, but their projected cash flows, discounted to the present value.
The amount by which that future cash flow value is discounted is the discount rate, expressed as a percentage. The example of the bond is a more clear-cut case than most of those faced by the advisors valuing a business: the risk and predictability of return of a bond is very simple compared to that of a restaurant, for instance, or a patent, or a piece of real estate.
Two different advisors may come to different conclusions about the discounted cash flow value of an asset, and presenting their reasoning to the prospective buyer is part of the process of considering an acquisition, especially if the acquisition itself will in any way impact that cash flow.
The guideline companies method of business valuation is a benchmark-based method similar to determining the value of an asset like a car or house: the company is compared to other similar companies that have been acquired, with multiples calculated based on differences in areas like price-to-earnings ratio.
This has become a more useful method as acquisitions have themselves become more common, as the number of available benchmarks has increased, in some industries more than others. Intellectual property, like patents and proprietary processes, are especially difficult to value objectively. Various models have been developed, and there are firms that specialize in the valuation of intellectual property, a specialty that has developed principally since the s.
It is standard for both parties to sign a non-disclosure agreement, though the targeted business could still be at a competitive disadvantage should the other business opt not to go ahead with the acquisition. Data is reported in such a way as to make comparison to other businesses in the industry as easy and accurate as possible, and certain other adjustments are made to the report as circumstances demand: no operating assets which are assumed to be excluded from the hypothetical sale, such as excess cash are eliminated from the balance sheet, non-recurring items are adjusted so as not to skew the results of the analysis, and the data of private companies is sometimes adjusted to make it comparable to that of public companies.
Executives of private companies often earn a higher salary than those of public companies, for instance. Each publishes a set of Business Valuation Standards for its accredited members to follow. Financing Financing an acquisition is another consideration. Money can also be raised through bonds or loans from a bank, and it is common to finance an acquisition through some combination of these things.
Leveraged Buyouts A leveraged buyout LBO is a special type of acquisition, differentiated by the way it is financed. Merger and acquisitions are used by companies to produce greater worth for stockholders and shareholders.
Make sure to provide an example of each type. Identify and explain some defenses to acquisition. What are the financial statement rules with respect to acquisitions?
Bruner states that the valuation of the merged and acquired companies as a result of these activities, are as a result of value conserved, value created and value destroyed. Value conserved occurs as a result of merger and acquisition activities when investment returns are equal to the required returns. As a result, investors are able to get their returns before the deal occurs. Secondly, value is created as a result of merger and acquisition activities when the level of investment increases more than the amount of returns required by the investors.
Similarly, the returns earned by the investors are more than their expectations even before the deal is completely implemented. On average, smaller acquirers realise higher abnormal returns than larger acquirers Moeller, Schlingemann and Stulzrm, Thirdly, according to Bruner , value destruction also occurs when the return on investment reduces the required returns amount, here the investor is unable to get the returns as expected before the deal occurs.
The impetus for businesses to pursue between a sale and a merger may involve estate planning, a need to diversify its investments, an inability to finance growth independently, or a simple need for change. In addition, some businesses find that the best way to grow and compete against larger firms is to merge with or acquire other businesses.
It is important to note that for a merger to be successful and beneficial to the parties involved each side should add value so that together the two are much stronger. Smith points out that many mergers fail to work. He identifies overpaying for the acquisition as a common mistake because of an incomplete valuation model. It is thus essential to develop a complete valuation model, including analysis under different scenarios with recognition of value drivers.
Only then can the value of an acquisition be better realised. In general, value is created in a merger and acquisition when the following key parameters are addressed. These parameters determine whether the merger will improve the strategies of both companies, if there is sufficient resources allocated for integrating the two companies, if integrations takes place by design and not by chance, whether both companies have prepared for integration in advance through due diligence, if human and cultural issues are directly addressed as part of integration, and if the integration process is viewed as evolutionary with several concurrent projects going on in trying to integrate the two companies as quickly as possible Smith, According to DePamphilis , work covered by other authors on whether mergers and acquisitions create value or not, can be summarised as follows: ' Acquirers overpay for growth companies excessive premium ' Shareholders profit by selling around announcement dates ' Long-term performances of combined companies improve ' The method of payment affects long-term returns i.
In a merger, two companies combine to form a new entity, whereas during an acquisition, one company seeks to purchase another. In an acquisition, the acquiring company is making the purchase and the target company is being bought. According to Cavallaro , a merger can be statutory, where the target company is fully integrated into the acquirer and thereafter no longer exists. A merger can also be a consolidation, where two companies join to become a new company or a merger can be subsidiary, where the target company becomes a subsidiary of the acquiring company.
There are different types of mergers: horizontal, vertical, conglomerate and congeneric. In a horizontal merger, a competitor or a related business is acquired. Here the acquirer is looking to achieve cost synergies, economies of scale and gain market share. An example of this is the merger between Daimler-Benz and Chrysler. A vertical merger is an acquisition of a company along the production chain.
An example here would be a car company purchasing a tyre manufacturer. In a conglomerate merger, a company completely outside of the acquirer's scope of core operations is purchased.
A congeneric merger is a type of merger where two companies are in the same or related industries but do not offer the same products Goldsmith In a congeneric merger, the companies may share similar distribution channels providing synergies for the merger. An acquisition is an activity where an entire takeover of the organisation takes place and one company targets to buy another company. Changes in corporate control can happen because of a hostile bid which is contested by the target's board and management, or friendly takeover of a target company, or because of a proxy contest started by unhappy shareholders.
According to Morck, Shleifer, and Vishny b , there are many theories that explain why managers resist a takeover attempt. The management entrenchment theory is one such theory which suggests that managers use a variety of takeover defenses to ensure their longevity with the company. Hostile takeovers, or the threat of such takeovers, have historically been useful for maintaining good corporate governance by removing bad managers and replacing them with better ones. The shareholder interest theory is used to increase the purchase price to the benefit of the target company's shareholders while the proxy contest theory is applied when a dissident group of shareholders attempt to gain representation on the company's board of directors or change management proposals Ertimur, Ferri, and Stubben Here the potential acquirer initiates an informal dialogue with the target's top management, and the acquirer and target reach agreement on key issues early in the process.
There are several types of hostile takeover tactics, including the bear hug, proxy contest, and tender offer. With the bear hug tactic, the acquirer mails a letter that includes an acquisition proposal to the target company's CEO and board of directors. The letter arrives with no warning and demands a quick response, to move the board to a negotiated settlement. The bear hug also involves a public announcement as well. Directors who vote against the proposal may be subjected to lawsuits from target shareholders, especially if the offer is at a substantial premium.
In a proxy contest, dissident shareholders attempt to win representation on the board of directors. The dissidents then initiate a proxy fight to remove management due to poor corporate performance. By replacing board members, proxy contests can be won by gaining control without owning Instituting a proxy contest to replace a board is costly, which explains why there are so few.
During the period and , an average of 12 companies annually faced contested board elections The Economist, A hostile tender offer tactic is a deliberate effort to go around the target's board and management to reach the target's shareholders directly with an offer to purchase their shares. Potential bidders often purchase stock before a formal bid to accumulate stock at a price lower than the eventual offer price.
Tender offers can be cash, stock, debt or some combination of the three. According to DePamphilis , there are quite a few advantages to hostile takeovers. One is that the friendly approach surrenders the element of surprise. Even a few days warning gives the target management time to take defensive action. The friendly approach allows for negotiations to raise the likelihood of a leak and that will lead to a hike in the target's share price which would then add to the cost of the transaction.
Successful hostile takeovers depend on the premium offered to target shareholders, the board's composition and the composition and sentiment of the target's current shareholders. In an acquisition deal, the acquiring company estimates the cost of acquiring the other company to gauge how profitable the takeover will be in the long-run.
.Jagersma offered six reasons which included; economies of skills, expansion, economies of scale, market entry, geographic risk spreading and financial. Only then can the value of an acquisition be better realised. On the other hand, a hostile takeover, when the purchased company resists being acquired, is never called a merger.
Reilly and Robert P. Here the potential acquirer initiates an informal dialogue with the target's top management, and the acquirer and target reach agreement on key issues early in the process. There are several types of hostile takeover tactics, including the bear hug, proxy contest, and tender offer. The merger and acquisition activities also lead to improvement in the value by increasing the long-term performance of the firms that have merged or acquired. Neary studied international cross-border bank mergers between and , and utilised a theoretical framework proposed by Pehrsson that categorised bidders into strategic market-asset and efficiency-seekers. It is likely that not every group mentioned will benefit from mergers and acquisitions, but a commonly accepted criterion is that the outcome is socially desirable if the benefits exceed the costs.
The focus of accounting research questions whether there has been an improvement in the numbers of accounting that follow mergers and acquisitions. The discounted cash flow method also discounts future cash flow projections from the newly formed company to its present value.
An acquisition is an activity where an entire takeover of the organisation takes place and one company targets to buy another company. It is crucial though that when this process is put under the spotlight, one must consider the impact on shareholders, creditors, employees, management, and customers of participating companies and competing firms. The amount by which that future cash flow value is discounted is the discount rate, expressed as a percentage. Further, while it is in the best interest of public companies to emphasize their profits, it is in the best interest of private companies to minimize them to some degree, for the sake of taxes, and financial records will reflect this.