Synergies are the basis of most strategic business acquisitions, thus valuing and understanding synergies on both the buy and sell-side of transactions is a crucial negotiating tool for any successful transaction.
Strategic buyers should be looking to acquire firms for a price lower than the sum of their targets stand alone value plus the sum of the calculated synergies. On the sell-side, it’s important for business owners and management to be aware of the value of potential synergies in order to best negotiate with potential acquirers. As a seller, it’s necessary to try and negotiate a price as close as possible to that of the sum of the firm and potential synergies.
Revenue synergies are derived from two companies selling more than they would have as separate entities. This can be ascertained through a number of methods such as cross-selling, gaining access to new markets, rebranding, distributing similar products, higher margins from reduced competition and many more. When calculating revenue synergies it’s important to undertake a thorough due diligence and understand each company’s target market, particularly if calculating cross-selling synergies.
Cost Reduction Synergies
Cost reduction synergies are generated from reduced costs and improved cost efficiencies. The most obvious synergies are through economies of scale in areas such as better use of office or factory space, but also includes reduction in employee numbers to avoid the duplication of work, which is most common for administrative and back-office roles.
Asset Reduction Synergies
Asset reduction synergies arise from assets that are no longer required when firms merge their teams. Often less efficient plant or more isolated headquarters are sold off, generating cash for more efficient expansion.
Tax Reduction Synergies
Tax reduction synergies can require highly specialised tax advice. The most obvious tax reduction can be through increased depreciation tax shields. A more complex, but also potentially more lucrative synergy can be that of transferring losses to the merged firms profit and loss statement which can generate a significant tax saving.
This is not a type of synergy, but the most widely used and necessary way to calculate the impact of a synergy into the value of a business. In short, the sum of all the above mentioned synergies equals the free cash flow they generate after tax, less investments in net working capital, divided by 1 + the weighted average cost of capital.
Ultimately, when acquiring or merging a business, calculating, and then realizing synergies is arguably the most crucial step in ensuring the process is successful. Companies that fail to do this when selling or acquiring are not maximizing their potential, and running the process at a higher risk.
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