A company looking to make an acquisition will typically consider “synergies”; they often play a crucial role in justifying the acquisition and driving value. Synergies are the strategic advantages gained through the combination of two organizations' resources, capabilities, and market positioning. –To put it more simply, how will the whole of the two businesses be bigger than the sum of the parts – what cost savings can be made and what extra revenue or margin can be gained.
Understanding Synergies in Acquisition:
When evaluating an acquisition, it is essential to consider the potential synergies that can be realized. Synergies can be broadly classified into two categories: hard and soft synergies. Hard synergies are tangible and measurable, while soft synergies are more intangible and challenging to quantify.
Hard synergies are typically more certain and have a direct impact on financial performance, making them easier to identify and quantify. They often revolve around cost savings, operational efficiencies, and economies of scale. Examples of hard synergies include streamlining supply chains, consolidating overlapping functions, and using shared infrastructure. A concrete example might be that a business with a warehouse at 75% capacity acquires another business which fills the other 25% and so saves warehouse costs. By capturing hard synergies, organizations can improve profitability, enhance cash flow, and create value for the owners. A business considering an acquisition must be confident of achieving these synergies to a high degree of certainty.
On the other hand, soft synergies are less quantifiable but equally important for success. These synergies are often related to strategic advantages, such as expanded product offerings, increased customer base, cross selling, or access to new markets. Soft synergies are usually associated with sales growth and better margins examples might include selling your product to the target company’s customers or assuming that you can negotiate better margins due to extra scale. The important point to note is that these are hard to quantify accurately and not straightforward to deliver.
Differentiating Hard and Soft Synergies:
Differentiating between hard and soft synergies is crucial for acquisition evaluation and decision-making processes. By categorizing synergies appropriately, organizations can better understand the potential value creation opportunities associated with the acquisition. This distinction allows companies to set realistic expectations and plan accordingly.
Synergies in Acquisition Pricing:
Typically, companies pay a multiple of maintainable EBITDA as the purchase price. Ideally, the purchase price should not include synergies – that way the purchaser gets the value of the synergies. During negotiations the buyer might be willing to pay for some of the projected synergies to close the deal. This is where the distinction between hard and soft synergies is important. Soft synergies are theoretical and might never be achieved – if you pay for them you run the risk of destroying value rather than creating it. Only ever include hard synergies in a purchase price. If the deal requires a price for soft synergies then it’s probably not the right deal.
Considering synergies in an acquisition is vital for creating a compelling rationale and driving value for both acquiring and acquired companies. By carefully differentiating between hard and soft synergies, organizations can assess their potential impact on financial performance, operational effectiveness, and strategic positioning. While hard synergies are often quantifiable and easier to realize, soft synergies provide long-term growth opportunities and unique competitive advantages. By seeking the right synergies and avoiding their inclusion in pricing negotiations, companies can build successful, value-creating acquisitions that lead to sustainable growth and improved market competitiveness.
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