How to Avoid Risks During Mergers and Acquisition

Mergers and acquisitions can be a double-edged sword for a parent company. A merger arises when two different entities join forces to establish a new, joint organization. On the other hand, an acquisition is the annexation of one entity by another. Essentially, mergers and acquisitions may be accomplished to increase an organization’s scope or acquire market share as it tries to establish shareholder value (Sarala et al., 2016). As for the enterprise development’s strategy, it can enlarge the productivity scales and minimize the cost of producing, gaining advanced high technology and getting into the new fields rapidly, etc. However, numerous real examples prove that the success rate of mergers and acquisitions is not that high. There are lots of uncertainties and risks during the procedures. How to avoid these risks would be a severe problem for a parent company to consider, when two businesses come together, whether, by means of a merger or an acquisition, the two entities cease to exist separately and all the assets will be pooled (Sarala et al., 2016). The main reason that two firms will come together is the belief that there is a financial gain from doing so as opposed to operating separately. These financial gains are called synergies. This paper will discuss the problems caused by mergers and acquisitions as well as the solutions to address them. The paper will also seek to prove that adopting several ratios and models would be useful to identify whether acquiring or merging is valuable for an initial parent company.

Problem

How much benefit can companies gain in M&A?

Due to the stock markets’ depression and the change in the environment of business operations, many companies choose to do mergers and acquisitions (Pelov & Nguyen, 2018). It can be forced to the elimination of competitors, the sharing of knowledge, makes the parent company can have to cross-sell their products, and enlarge their economies of scale.

Many parent companies would like to enlarge and expand their scales through mergers and acquisitions. For example, if a company plan to rise 20% of the profit, mergers, and acquisition would be an excellent choice for it (Howson, 2017). However, the merger and acquisition would usually cost much time and human and financial resources. Furthermore, the process of that would also be extremely complicated. For instance, the Chinese carmaker Zhejiang Geely Holding Group completed the acquisition of Volvo from Ford Motor successfully in 2010.

Furthermore, Geely acquired Volvo while Volvo had a hard time in its operation. Volvo had a considerable loss during the last five years, almost 1 billion dollars per year. Geely successfully got a higher-class car brand and gained the technology of Volvo at an appropriate price (CHRIS V. NICHOLSON 2010). Only 1/3 of the companies can do it in other positive or proper ways of mergers and acquisitions. Some managers usually do mergers and acquisitions in haste by being under pressure from internal or external peers(Lee, Mauer, & Xu, 2018). However, the merger and acquisition would usually cost much time and human and financial resources. If it is a cash offer, the companies will face much liquidity pressure. Moreover, if it was a share for a share offer, the parent company might get some loss of control or unknown price consideration.

Solution(s) & Implication(s)

Using Ratios to quote the company

First, the company needs to consider whether it is necessary to do a merger or acquisition. Second, the managers need to understand deeply the value of the resources, and if it is a lack of internal research force problem, they have a contract with an external co-operator who can offer resources would also be the right choice (Green, 1990).

Evaluation (of using methods)

The enterprise can have deep research of valuation, the first subsidiary, with P/E ratio, dividend valuation model, NPV, etc.

Using the P/E ratio

The P/E ratio can be utilized to determine the value of the entire business. It could aid an organization to evaluate the level of risk of the organization and therefore estimating the strength of anticipated earnings (Lebedev et al., 2015). However, when utilizing the P/E ratios for the quoted companies would have some difficulties valuing unquoted companies. Because these quoted organizations are usually diversified and finding quoted companies would have a similar range of activities. It is not suitable for unquoted companies, because a quoted company might have a distinct capital structure belonging to the unquoted company (Lebedev et al., 2015). Therefore, the implication of the P/E ratio enables a company to analyze its risks and capitalize in its opportunities so as to improve its future earnings.

Using the Net Asset Valuation method

The Net Asset valuation is a technique providing lower limits for valuing an organization and is implausible to be genuine since it disregards intangible assets like Goodwill which means the intangible value of a business over the net book value, on the basis of its reputation as well as customer loyalty. The brand value represents an element of Goodwill (Cartwright & Schoenberg, 2006).

This method can help in measuring comparison within a scheme of the merger by measuring asset backing, as well as being resourceful to value property investment. However, it would have challenges to determine the asset values to utilize since individual asset figures might vary substantially based on if it is valued on a concern or break-up basis. For instance, assets may be valued by utilizing realizable, replacement as well as a historical basis, and the accuracy relying on the chosen one. This approach disregards non-balance sheet assets like top skilled workforce, especially in high-tech companies.

Using a dividend valuation model.

The dividend valuation model refers to a valuation method on the basis of dividends. This model is suitable to undertake value on non-controlling interest. It is also resourceful to value property investment organizations. There are plenty of risks and uncertainties in regular companies. The model does not consider the shareholder’s different expectations. While dividends may motivate some, some might opt for future capital appreciation of their shares (Lebedev et al., 2015).

If the company plan to do mergers and acquisition and wants to save time more, the cash offer would be a better choice. It is the equity shares in the target company. They are purchased from the shareholders for cash. The parent companies would not have to have the sharing of control, and if cash surpluses are available, it can be quick. Moreover, it would have a guaranteed purchase price. However, this method might cause some liquidity problems or tax implications (Lee et al., 2018). If the company plan to avoid the liquidity risk, share for share exchange would be a better choice. It can avoid liquidity issues, and it can finance significant acquisitions. However, the parent company might have a loss of control and face unknown price considerations.

Conclusion

To sum it all up, it is clear that there are many methods to do mergers and acquisitions; entrepreneurs or CEOs would have to consider more about their companies and initial subsidiary’s situations. Finally making a suitable decision and plans to avoid the risks and choose the best way to do the mergers and acquisitions would be a necessary step for them to do.