Synergy Tracking in M&A: What Are Synergies and Why Are They Important?
Synergy tracking in M&A is increasingly vital as executives realize that moving faster in the evaluation and implementation stages can lead to increased benefits. Digitizing for synergy tracking in M&A may increase deal speed, reduce costs, and enable you to create new M&A strategies.
Digitizing M&A, a report by Accenture Strategy states:
“For a U.S. $1 billion revenue business sold at the median industry EBITDA multiple, being able to complete a transaction three months earlier can generate significant value. We have seen up to U.S. $15–30 million for the buyer and U.S. $15–45 million for the seller.
These are not castle-in-the-sky figures. They are actual advantages savvy companies create by using digital technologies to support their deals — adding speed and enabling new M&A business models. Your company can do the same.”
A quick look at what synergies are, the types of synergies, and the obstacles to realizing them will demonstrate the critical importance of digitizing for synergy tracking in M&A.
What Is Synergy in M&A?
Synergy in M&A means the additional value created by combining two businesses is greater than the value of their individual components. The amount above the actual physical value is called synergy. It is what companies are willing to pay a premium for.
Suppose company A has a value of $400 million and company B is valued at $200 million. Company C, created by merging companies A and B, is worth $700 million. The synergy is $100 million.
The formula M&A professionals often use to calculate synergy is:
Synergy = NPV + P
NPV is the net present value of the new company, and P is the premium.
Arriving at an accurate synergy figure isn’t easy, but using M&A software solutions can help improve the speed and accuracy of evaluations. To further aid valuation, professionals break synergy down into three primary types:
Executives usually divide M&A synergies into three basic types:
Some M&A professionals use two other ways of grouping synergies. You sometimes see combinational and transactional or operational and financial categories, with both operational and combinational lumping revenue and cost together because they are easier to evaluate for synergies.
The premise that two companies combined will generate greater sales than the combined value of their present sales is what guides revenue synergy valuations.
Revenue synergies can come from multiple sources. The most common are:
- Cross sales
- New markets
- Reduced competition
Executives often expect revenue synergies to be one of the most significant portions of total synergy. Still, in actual practice, most companies discover that realizing revenue synergies is more elusive and takes longer than realizing cost synergies.
McKinsey & Company reported an average gap of 23% between goal and attainment, with the revenue synergy realization process usually requiring five years. Challenges faced by businesses McKinsey surveyed included:
- Setting achievable targets
- Aligning salesforces
- Implementing across functions
- Evaluating financial results
- Rallying everyone to work toward common goals
Companies that did report success cited the importance of:
- Owning synergies and reporting monthly on revenue progress, from leadership and the front line
- Using customer-level insights to identify opportunities.
- Having bold targets and giving incentives to meet them.
- Installing the support that’s critical for execution and evaluation.
Using a complete M&A software gives companies the tool they need to provide support and realize revenue synergy targets.
Businesses usually realize cost synergies in the first two years of operation, faster than revenue synergies.
Cost synergy reflects the reduction in costs achieved by merging and streamlining operations. After joining, the two companies may have duplicate departments like HR and Legal that they can combine and possibly downsize to realize cost synergies.
Other common areas where companies can realize cost synergies are:
- Supply chain improvements: Purchasing larger quantities may result in better deals.
- Research and development: Applying advances across both companies can result in new products and production increases that reduce costs.
- Lower salaries: C-suite and some staff positions command hefty salaries. Companies can eliminate or reduce duplicate jobs.
While cost synergies can be more challenging to implement in practice than on paper, they are still easier to calculate and put in place than financial synergies.
The area many executives expect to see the most significant gains in synergy is financial, but this is often the most challenging to evaluate. Reduced capital costs can be the biggest benefit, but other important sources of financial deal synergies exist.
Increased Competitive Advantage
A broader customer base can result in lower competition. Market share, revenue, and cash flow may increase, reducing the cost of equity.
There are many tax implications involved in mergers and acquisitions. A profitable company acquiring a losing business may be able to use the net operating loss to reduce taxes. Other tax benefits can come from depreciation, unused debt capacity, unused tax losses, and surplus funds.
Expanded Debt Capacity
When two companies merge, the combined firm can often increase debt. It can get more favorable loan terms and lower interest rates
because the capital structure improves as cash flow and earnings grow and become more predictable.
Even though synergies provide significant benefits motivating M&A, the obstacles encountered cause an estimated 70% to 90% to fail.
Obstacles to Realizing Synergies
While the expected synergies brought by M&A can be enticing, there are substantial obstacles to completing a deal and then shepherding the new firm through integration to provide the estimated benefits.
Executives may fear that investing substantial time and resources into evaluating the opportunity, structuring the deal, and then making it work will detract from the company’s core business.
Failure to Publicly Announce Deal Synergies
“Only about 20 percent of companies — and this is in large deals — are announcing their synergies publicly, despite evidence that companies that do announce them perform significantly better two years after the deal.”
Jeff Rudnicki, McKinsey & Company, A Winning Formula for Deal Synergies
Most companies give themselves a buffer by hedging their synergy estimates by about 50%. A firm announcing a $100 synergy probably has an internal target of $150 million. A danger of hedges is that executives sometimes apply them to an already hedged figure which grossly distorts the synergy valuation.
Analyzing data and gaining approval from all stakeholders at each level of the delivery process can be quite a time-consuming endeavor without a system to facilitate the workflow. Firms moving fast through the integration phase stand a better chance of realizing the estimated synergies.
Jeff Rudnicki shares that getting back to doing business as usual within 18 months is a good goal. Moving too slowly may allow a dominant culture or business to become entrenched when the goal should be returning to core business activities as soon as possible.
Combining resources yields some of the quickest, most tangible benefits in M&A. But resource integration and optimization of culture, technology, procedures, practices, and talent to achieve peak success can be challenging.
Recording and tracking a major merger’s intricacies can be a daunting time and energy-consuming chore if the company uses manual record-keeping for some aspects. When individual team members keep their own records, others may be operating in the dark, making it easy for errors and duplications to creep in. Having all documents in one location and accessible keeps everyone informed and working together.
Dealing with Massive Amounts of Data
A Dell Global Data Protection Index study found that compared to 2016, companies today manage ten times as much data. Analyzing this massive amount of data is challenging for M&A dealmakers, who must do their due diligence and arrive at accurate synergy estimates.
Digitizing Is the Optimal Answer
The desire to capture synergies is the biggest motivator for most M&A deals. However, few companies manage to completely realize the full potential of all revenue, cost, and financial synergies because of the many obstacles and complexities facing M&A deals today.
Fortunately, digitizing for synergy tracking with complete M&A software can substantially reduce all of the obstacles and manage intricacies. You may be able to complete more deals successfully and realize more significant synergy benefits faster. Discover how one of our customers, Sipchem overcame similar challenges in this highly informative case study.