M & A Viewpoint: The Cost of an Acquisition
Acquisition Funding Costs
The costs of acquisition funding fall into two basic categories. First, there is the cost of obtaining the funding. The second set of costs is the actual returns paid to funding sources (both debt and equity).
Cost of Obtaining Funds: Depending upon the size and complexity of the transaction and required funding, there can be investment banking and placement fees equal to several percentage points (as negotiated) of the amount of funding. In addition, there can additional legal work plus closing, document and insurance costs. The costs of obtaining funds are usually paid at funding from proceeds.
Return to Funding Source(s): Once funding is in place, a return has to be paid to the funding source(s) according to the terms of the instrument or agreement.
||Expense or Cost
||Interest or Coupon Rate paid to Holders
||Dividend paid to Holders plus their expectation of appreciation
||Interest and Coupon Rate paid to Holders plus Costs of Equity (also potential dilution issues)
||Yield paid to Holders
There are also indirect capital costs. An excessive degree of leverage may change your credit rating and result in an incremental increase in your corporate borrowing rates (interest, advance rates and repayment periods). A reduction in credit capacity will cause the company to either pay more for money (if it can get it) or ratchet down further expansion.
In addition to outside services, there are a number of internal costs that are borne by the buyer. These are the costs of involved in evaluating, planning, coordinating and directing the transaction and moving it through the corporate approval/governance process. These costs include staff salaries, travel, research and preparation of presentation materials.
Assimilation and Operating Costs
Assimilation costs are those costs that are necessary or arise out of the buyer’s efforts to bring the acquisition under control. In a merger scenario, the goal is to integrate the newly acquired business as opposed to assimilating it. Assimilation costs can be incurred to retain and retrain a workforce, replace management information systems and to modify or blend benefit programs. There may be additional consultant costs if one is brought in to facilitate the assimilation or integration. Assimilation and operating costs are usually paid from cash flow as they are incurred.
While acquirers look for cost-saving opportunities, the acquisition may also increase some operating costs. An acquisition can create a certain amount of organizational stress that can diminish employee productivity and can also result in customer attrition. If it is necessary to reduce staffing or labor costs, there may be charge-offs as well as an increase in unemployment insurance costs. It may be necessary to review and increase the limits of insurance coverage resulting in higher premiums. Depending upon the quality of the target company’s financial reporting there may be additional accounting costs to meet the requirements of funding covenants and to satisfy investors.
Outside services, funding, internal transaction management and assimilation and operational costs can add up, but there are still hidden or intangible costs. These costs are intangible because they are not easily defined.
An acquisition may have an opportunity cost. By making an acquisition you are deploying strategic resources that could have been used for organic growth, to make a different transaction or an alternative investment. In addition, the assimilation or operation of the newly acquired company may require more management attention than planned. Remedial management takes attention away from other business issues.
There may also be undisclosed or unexpected liabilities that can arise as a result of the acquisition. If you have booked Goodwill as a result of the acquisition, future impairment of the Goodwill may necessitate a write-down which will impact the balance sheet and, possibly, your ability to raise capital in the future.
Control and Manage Costs From the Beginning
There a many good reasons why you want to identify, manage and control the costs of a transaction throughout the evaluation, due diligence, closing and assimilation process. For one thing, mounting pre-closing costs can create pressure to “expedite” the evaluation process. In addition, the more time and money you have invested in a prospective acquisition, the more psychologically difficult it is to walk away from the deal because that would mean the loss of these sunk costs.
Cost-consciousness is also a counterweight to what has been called the synergy trap (the title of a very helpful book by Mark Sirower). When we buy a business it is natural to look at and quantify the synergies and anticipated benefits of the deal. In many cases, this exercise is an unconscious hunt to find justifications to support the decision to make the acquisition. As an opportunity-driven executive, there is a natural tendency to look for reasons why the glass is half full. This is a bias and it can hamper the process of sound decision making. The hidden danger is that while you are busy seeking synergies and cost saving strategies, you may very well be overlooking the costs of making and maintaining the acquisition.
So, as a buyer, the next time you are considering an acquisition, ask yourself: “Beside the transaction price and related costs, what is this company really going to cost? How much time and money is it going to require? Is the deal really worth it?” The answer may surprise you. It may also save you an immeasurable amount of grief!
About the Author:
Robert B. Machiz is a founder and president of MoneySoft, Inc., a publisher of software for valuing, pricing and simulating the financial outcome of Mergers and Acquisitions.
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