The acquisition strategy must be consistent with the company’s overall strategic goal of increasing net cash flows and reducing risk. This article will explain the purpose of acquisition strategies evaluation and how to do it.
The role of strategy in acquisitions
Mergers and acquisitions (M&A) are an important element of the strategic management of an economic entity, which is carried out to increase its potential and ensure its strategic invulnerability. M&A deals are a complex multi-stage process that takes a long time. As a rule, large material, financial and human resources are involved in it. In addition, the M&A transactions include strategic, tactical, and operational levels of its implementation.
Strategic planning identifies a company’s competitiveness and sets goals to capitalize on its relative strengths while minimizing the impact of weak business elements. The company’s M&A strategy should complement this process by targeting only those industries and companies that can enhance the buyer’s strengths or reduce the weaknesses’ negative impact. By having a strategic acquisition plan focused on this goal, management can reduce the cost and time spent analyzing and selecting emerging investment opportunities.
As a rule, the main advantage of acquisition over internal development is the faster achievement of business goals. In addition, takeovers help mitigate the risk of a buyer moving beyond its core business. An established business brings with it one or more of the following:
- reputation;
- management;
- competence;
- products;
- trademarks;
- client base.
Internal development may not have all of these benefits. The target company may also have weaknesses that should reduce its value as a separate business. These attributes should be considered against the buyer’s ability to evaluate their impact on future results.
Acquisition strategies evaluation
Evaluating the effectiveness of acquisition strategies is the process of calculating quantitative and determining qualitative indicators that characterize the feasibility, rationality, and effectiveness of the implemented merger or acquisition strategy. There are different approaches to evaluating the effectiveness of integration transactions. For example, if merging companies operate for a long time, it is recommended to use the cost approach, which consists of estimating net assets’ value.
So, there are the following main approaches to acquisition strategies evaluation:
- The cost approach to assessing the value of a company is based on the assessment of real assets. Therefore, it reduces the degree of estimation uncertainty. However, the disadvantage of the approach is that it does not consider the prospects for the future development of the business.
- The comparative approach (the method of coefficients) is that the value of the enterprise is determined based on a comparison with other companies with similar characteristics. Although it is impossible to find completely identical companies, therefore, in any case, the assessment is made with some degree of assumptions.
- The income approach is based on the discounted cash flow method. For its use, two indicators are determined: the forecast value of future cash flows and the discount rate. All estimates are probabilistic with a significant degree of uncertainty. The complexity of using the income approach lies in the correct forecasting of future financial flows of companies.
- It is possible to evaluate not only a future merger and acquisition transaction but also an already completed transaction. It can be important to understand whether a transaction was successful or unsuccessful sometime after it was made. The retrospective evaluation considers actual performance, not the ratio of the results obtained to the costs incurred. Retrospective evaluation can be based on accounting and production indicators.