The Institute for Mergers, Acquisitions and Alliances reports that almost 400,000 M&A transactions have occurred in the U.S. since 1985. This includes nearly 15,000 in 2023 alone. While recent uncertainty and higher interest rates have suppressed M&A activity recently, mergers and acquisitions are poised to trend upward in the coming months and 2025 due to multiple factors, including lower interest rates and a strong economy.
Is your small business preparing for a merger or acquisition? Are you one of the many business owners of a certain generation looking at selling your business as your exit strategy? Start to familiarize yourself with the process before you put your business on the market.
What Are Mergers and Acquisitions?
“Mergers and acquisitions” (or “M&A”) is the general term for all manner of transactions in which businesses change hands. While some people use the terms “merger” and “acquisition” interchangeably; they are different concepts. Understand what separates the two before addressing one or the other.
Mergers
A merger occurs when two companies merge, and only one survives or they combine to create a new company in pursuit of greater collective success than the the two companies would have by continuing as separate businesses.
An example is Extra Space Storage Inc. and Life Storage, Inc. merged in 2023 to become the biggest U.S. storage business operator.
Mergers typically involve similarly sized companies and are designed to advance companies to the next level within their respective industries.
Acquisitions
An acquisition is when a person or a company (the “acquirer”) buys another company (the “target”) and becomes the new owner. A company usually acquires another company to expand into a new business sector or to strengthen its industry standing.
An example is Amazon’s acquisition of Whole Foods in 2017, which enabled the tech giant to expand into the grocery industry.
Usually, an acquisition involves the willing participation of two companies. However, it can also include a hostile takeover, in which shares of a company that doesn’t necessarily want to be purchased are purchased from the company’s shareholders without the participation or approval of the target’s board of directors.
While we have mentioned several large, public companies, M&A issues are critical in the life of small and medium-sized businesses as well. There is also a growing movement of “entrepreneurship through acquisition” (or “ETA”) where young entrepreneurs are choosing to buy existing small businesses instead of starting from scratch.
DifferentTypes of Mergers and Acquisitions
There are several specific types of M&A, including:
- Mergers (or Consolidations): When companies combine to improve their market share and reduce competition, or achieve economies of scale or synergy
- Stock purchases: When one company buys outstanding stock from another company
- Asset Purchases: When one company purchases assets from another company
- Management acquisitions: When executives from one company secure a controlling stake in another company
Factors To Consider Before Mergers and Acquisitions
Mergers and acquisitions for small businesses are common, but it is important to prepare yourself and your company before entering into any transaction. Start by familiarizing yourself with various elements of M&A so you and your business will be better prepared to engage meaningfully in the transaction negotiation and process.
1. Types of M&A Transactions
First and foremost, what is the purpose of the transaction? While a seller or target may not be as invested in this question as the acquirer, most of the time, the seller’s benefit is at least partially dependent on what happens after closing. For this reason, it is important for a seller to understand the “business case” for the transaction and understand what will happen after closing to ensure the seller achieves the anticipated results of the deal.
Here are some examples of strategic goals of an M&A transaction :
- Horizontal Integration: Involving two companies operating within the same industry and selling the same products and/or services
- Vertical Integration: For example, when a company buys a supplier
- Congeneric or Concentric:Involving two companies serving the same customers with different products and/or services merge
- Conglomeration: Involving two businesses in unrelated industries and markets, typically for diversification purposes.
2. How To Finance a Transaction
Second, how will the purchase price be paid? When one company plans to purchase another, it must first work out acquisition financing. A company can buy another company using:
- Cash
- Stock
- Assumption of debt
- Seller financing
- Earnouts
A company can also use more than one of these options to acquire another company. Relatively few transactions result in 100% cash to seller at closing, so you will want to protect yourself against post-closing risks to your purchase price.
3. How To Value a Target
Finally, and most critically, before a merger or acquisition, the acquirer and the target/seller must agree on valuation. This is tricky in acquisitions, in particular, since a buyer will want to acquire a targetfor the lowest price possible, while a seller will wantto collect as much purchase price at closing, in cash as it can. As stated above, gaps in valuation with creative use of various techniques.
Transactions are typically valued using metrics like:
- Multiple of EBITDA (earnings before interest, taxes, depreciation and amortization) or SDE (seller’s discretionary income)
- Discounted cash flow
- Comparables
Often gaps in valuation are bridged using earnouts, or payment of additional purchase price after closing if certain specified benchmarks in revenues or earnings are realized.
The Merger and Acquisition Process
Every M&A transaction plays out differently. However, each one will normally follow a similar course of steps. Below is a representative description of the life of a M&A transaction:
- The sell-side team (which can be one or more of brokers, lawyers, and CPAs) perform preliminary review and create a Confidential Information Memorandum (CIM) to provide to potential purchasers.
- Interested purchasers provide an Indication of Interest (or “IOI”) and execute a confidentiality agreement (or “NDA”) in order to get access to additional information to allow negotiation and execution of a Letter of Intent.
- Once the primary deal terms are agreed in a LOI, the Companies carry out due diligence and negotiate the definitive agreements.
- Closing.
- Post-closure integration and implementation.
Let Our Business Lawyers Lend a Hand With Mergers and Acquisitions for Small Businesses
This introduction barely begins to scratch the surface of the myriad issues involved in M&A. It is critical that, as early as possible, anyone considering any involvement in a transaction hire competent advisors, including lawyers and CPA’s with M&A experience, to navigate a transaction more smoothly and efficiently. Protect yourself against tax and liability risks unique to business transactions, and incorporate M&A into your exit strategy and estate planning by calling us at 919-787-7711 today if you are contemplating or are involved in a M&A transaction.