The fundamentals of a successful merger Featured

4:33pm EDT March 1, 2011
The fundamentals of a successful merger

Even as the economy shows some signs of life, many companies continue to struggle to survive. Sometimes a merger can actually be an effective resolution to their problems. A merger is a mutual decision of two companies to combine and become one entity, generally as two “equals.” Through structural and operational changes, the combined enterprise can cut costs and increase profits, improving the combined enterprise’s value for both groups of shareholders. An acquisition, on the other hand, typically involves the purchase of a smaller company by a much larger one, with the acquiring company’s management team usually running the operation.

“For those companies considering a merger, there are several factors that need to work together to make it successful,” says Curtis Campbell, partner, HMWC CPAs & Business Advisors in Tustin. “Merging companies immediately gain access to a larger customer base and greater clout in negotiating with vendors. Plus, overhead usually drops and the two companies are often able to pool capital resources. We typically advise clients in pre-merger financial projections, tax planning and due diligence, as well as post-merger accounting, tax and consulting services.”

Smart Business spoke with Campbell about some of the key issues to be considered in mergers.

What are major issues to consider prior to a merger?

Identifying and pursuing a merger opportunity is likely to take several months. While operational, sales and marketing issues often drive the initial excitement, the hard facts of a merger are that financial issues ultimately determine whether it will be viable. Therefore, you may find it helpful to hire a CPA as you attempt to answer these and other questions, such as:

• Can you agree upon the value of each company?

• How can it be structured to minimize taxes for ownership?

• What are the primary financial benefits driving the need for a merger?

• How do compensation levels compare?

You should also do thorough due diligence on all aspects of the other company (i.e., financial, operational, human resources, and sales and marketing). In some industries, it is important to give serious consideration to legal and regulatory requirements that can impact the potential merger.

How will valuation and ownership be determined?

More than any other issues, these concerns are the primary ‘deal breakers.’ In any merger, the combined entity considers the value of each entity prior to the merger, even when owners may say ‘we’re about the same.’ Sometimes an owner may have a ‘number in mind’ that his or her company is worth, which may be very unrealistic, and this breaks the deal. An independent business valuation professional can provide a resolution through developing an appraisal of each company, which can be from asset, income and market approaches.

When the value is agreed upon, the initial ownership percentages can be derived, allowing owners to decide whether they want to infuse additional cash (or other assets) in order to increase their ownership percentage. Of course, other factors are typically considered, such as paying a premium to those owners who ‘own the relationship’ with major customers. These are all part of the pre-merger negotiations that are fundamental to a successful merger.

How can the transaction be structured tax effectively?

Taxes play a role not only in personal income tax (i.e., capital gains) but also in corporate income tax. The tax structure of a merger is very important and can have a dramatic impact on the post-merger cash flow of a company. Your CPA can make a big difference in helping to decide upon and execute a favorable structure for after-tax cash flow. With the right situation, certain strategies can even have immediate results and lead to better profits and cash flow, even during poor economic times.

Are differing management styles a concern?

With multiple owners, they need to recognize that they may have less autonomy and less influence in a larger company. If your goals for the company and your approach to customers are significantly different from those of your partners, you’re probably headed for disagreements and frustration. Work ethics may differ — one executive may regularly put in extra hours, while another stays only as long as required. All of these problems can be mitigated through diligent pre-merger exploration and negotiation.

What about employee issues?

Some of the greatest benefits of a merger come from integrating operational routines and then eliminating redundant positions. You won’t need two CFOs or two presidents, so someone has to go or be reassigned to another position that is needed and allows the person to be productive. Job security, along with duties and compensation, are key issues for most employees in a merger. If your line employees react negatively to the new environment, you may initially experience increased turnover as well.

From a camaraderie standpoint, it is important to encourage a sense of unity and team spirit. Under the merged company structure, it is important to have clearly defined managerial roles to prevent employees from falling back to old reporting relationships and allegiances. The combined companies should also implement standard policies and procedures for all aspects of operations.

Curtis Campbell is a partner at HMWC CPAs & Business Advisors, one of Orange County’s largest local accounting firms. Contact him at (714) 505-9000 to discuss how your company or client could benefit from HMWC’s services.