Financial Synergies After An M&A Transaction – How They Add Value

Achieving financial synergies after an M&A transaction is one of the driving forces for dealmakers. The strategic partnership helps enhance efficiencies and improve the legacy company’s financial performance. That’s how they can hope to create value.

Post-merger, you’ll restructure the new company’s capital and operations which can lead to several benefits. These benefits result in lowering costs, efficient use of available funding and resources, and improved research and development.

You can also build a broader product portfolio to attract customers and raise sales and revenues. Read ahead to understand in detail how financial synergies work in M&A deals.

Financial Synergies Defined

Financial synergies in M&A are the positive financial outcomes that result when two companies enter a strategic merger. Pooling their resources and combining operations helps them achieve higher financial efficiency and enhanced performance than when they worked separately.

Mergers designed for financial benefits seek to grow shareholder wealth, raise share prices, and offer higher dividends. The surviving company grabs a strategic position within the market by gaining an edge over the competition and building resilience. It improves its chances of long-term success.

For example: Company A and Company B were valued at $250M and $200M, respectively at the time of the merger. If the surviving company has a valuation of $500M after the merger, that indicates a synergy of $50M.

Financial Synergies After an M&A Transaction – Core Advantages

Financial synergies are distinct from cost synergies and operational synergies that companies may achieve. When we talk about financial benefits, they are solely about how the merger enhances the legacy company’s financial standing. Here’s how that can happen:

Enhancing Debt Capacity

Once the merger is complete, the surviving company is likely to have stable cash flows, revenues, and profits. As a result, you’re in a better bargaining position to connect with lenders and investors for debt. You can also negotiate for cheaper interest rates, unlike smaller startups that must pay more.

Now that you have a bigger cap table and assets, you can apply for bank loans and offer collateral. Other channels of funding also become available such as revenue and debt funding.

You can leverage steady revenues to raise capital and pay it back out of the company’s earnings. Demonstrating adequate liquidity to apply for loans is another plus point.

Let’s try an example. Company A and Company B are small to mid-sized companies. Company B needs to raise funding and approaches a bank for a loan. However, the bank requires higher interest rates and terms and conditions that won’t work well for a fledgling company.

Company B merges with Company A to create a bigger business with a more robust financial profile and assets. Their surviving company has a stronger capital structure, consistent cash flows, and profits. It can now demonstrate creditworthiness and ability to meet its obligations.

Not only can the company now negotiate for more favorable interest rates and terms. But it also has a broader selection of investors to approach for funding and get it for reduced borrowing costs. Since the company is bigger, it evokes confidence from investors and lenders in on-time repayments.

Higher Creditworthiness

A larger company with a bigger scale of operations can leverage better relationships with vendors and suppliers. You can place bulk orders to source inventory, spare parts, components, and other inputs and get them for cheaper rates.

Negotiating for better payment terms and credit periods is also an advantage because you can free up liquidity. Diverting this liquidity toward expansion and other strategic initiatives assures success.

Tax Benefits

Although mergers result in tax implications, you can use the collaboration to lower applicable taxes. For instance, merging with a company running in losses allows you to lower your tax liability.

The legacy company can lower its tax burden by leveraging the Net Operating Losses (NOL) clause to offset taxable income. Taking over old and redundant assets gives your company depreciation credit. Any tax refunds the target company has accrued will now form a part of your company’s capital.

You may be able to take advantage of tax incentives and exemptions by restructuring operations. Also, work with qualified CPAs to integrate tax-saving financing and operational strategies. Entering into cross-border M&A deals to move operations to tax-efficient locations is also a possibility.

Higher Revenues

When competing companies merge, they can jointly cater to a larger customer base. Revenues are likely to grow quickly when the competitors no longer need to engage in price wars to attract clients. You can also ramp up R&D since you have the resources and can provide better product features.

Growing your product portfolio is another option and mergers typically build brand value thanks to customer confidence and loyalty. The brand can build a better market presence for consistent current and future revenues.

Lower Capital Costs

M&A transactions help companies get lower equity and diversify their portfolio. For instance, a publicly traded company purchases a private company operating in a different vertical. Or, when a larger corporation absorbs a startup. Equity costs can be lower for the merged company.

Leveraging advantages like a broader customer base, lower competition, higher revenues, and cash flows helps get a higher market share. Although factors like the particular industry and its size and scope also come into play here, accessing equity is easier.

Lower Operational Costs

Lower costs improve the company’s overall financial standing. Pooling resources, removing repetitive and redundant processes, and economies of scale are crucial financial synergies after an M&A transaction. You can also lower labor costs by terminating unnecessary positions.

Managing other overhead, production, marketing and advertising, and administrative costs efficiently helps increase the available liquidity. You can put the working capital to better use by diverting it toward growth opportunities. Streamlining account receivables is another advantage.

Higher Risk Diversification

Companies enter into different kinds of mergers such as horizontal, vertical, cross-border, or any others. Combining operations in different verticals, supply chains, geographical locations, and product portfolios allows them to diversify their risks.

The new company can capture a bigger customer base by offering better products and services and thus ensure profitability. The higher the diversity, the more assured the returns are likely to be.

This factor ensures that your company is more resilient to macroeconomic and industry-specific risks and regulatory and political changes.

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Downsides of Financial Synergies

Although financial synergies after an M&A transaction are the core objectives, sometimes, synergies can work in the reverse. Dealmakers should be prepared for the possibility of negative synergies. Or, when the new company’s valuation is lower than the combined valuation of the individual businesses.

Despite extensive due diligence, the acquirer may find that they have to invest significant capital to restructure the acquisition. For instance, hiring a new management team, paying off its outstanding dues, or dealing with unexpected tax liabilities.

Chances are that the IP you acquired is redundant by the time the merger closes or that it has liens. Several factors can take away from the financial synergies you anticipated. A good way to work around this risk is to include representations and warranties in the merger agreement.

Then again, buyers are sometimes willing to overlook potential downsides and pay a premium for the acquisition. That can happen when they anticipate other synergies that compensate for the potential losses.

How to Calculate the Financial Synergies After an M&A Transaction

Company CPAs may use different methods to calculate whether the merger has achieved financial synergies. They collect data based on the income statements such as the total value of the surviving company’s expenses against revenues. This data reflects on the total profits the company earned.

Evaluating the balance sheet shows debt capacity and a positive cash flow in the cash flow statement reflects positive synergies. Here’s a quick overview of the best strategies to use:

Net Present Value (NPV)

Synergy = NPV (Net Present Value) + P (premium)

The Net Present Value is typically considered an aggressive method for evaluating synergies. This method takes into account variables since as the estimated growth in revenues and cost synergies from the deal.

It also factors in discounted rates based on the risk, and the period for estimating cash flows. A positive NPV indicates that the merger is successful.

Acquisition Premium

The acquisition premium is the price the buyer pays over and above the target company’s calculated market value. The premium compensates the seller for the future profits and revenues the surviving company will likely generate. Or, the positive synergy value achieved from the merger.

The higher the premium the buyer pays, the higher is their expectations of positive synergies. However, higher premiums also indicate that the buyer is taking on more risk in case the synergies fall short. On average, premiums range between 20% and 50% of the deal value.

Synergy Multiple

The synergy method uses a common benchmark multiple for estimating the merger’s success. In most cases, the synergy multiple can range from 4x to 12x of the cost savings or growth in revenues.

Of course, relying on a single method is never advisable. This is why CPAs use a combination of methods for a more accurate estimate

Knowing how to value your company is essential to understand the synergies achieved after the merger. If the overall company value improves and is higher than the combined value of the deal participants, the merger is successful.

Some Great Examples of Mergers and Acquisitions

Vodafone Acquires Mannesmann

Vodafone’s acquisition of Mannesmann is known to be historically the biggest M&A deal ever which occurred in 1999. Adjusted for inflation, that deal would be worth $393B in 2024.

This deal positioned Vodafone, the UK’s biggest mobile operator, as the world’s largest company in the telecommunications space. Mannesmann was a German-owned industrial conglomerate company and the deal triggered a series of mega M&A transactions in the vertical.

In 2013, Vodafone went on to acquire Verizon for an estimated $173B in today’s value. When the deal closed, it was reportedly the third largest in history and gave Vodafone complete control over its wireless arm.

Facebook Acquires Instagram

Facebook’s acquisition of Instagram in 2012 for an incredible $1B is an excellent example of financial synergies. Reportedly, the social media giant paid in a combination of cash and stock. However, reports suggest that Instagram will continue to operate as an independent entity.

At the time of the deal, Instagram boasted 30 million users and the highest number of downloads on iPhones. The company had just released a version for Android users also and was Facebook’s answer to rival SnapChat. By 2018, Instagram had acquired more than one billion users.

In 2023, the photo-sharing social media site was valued at an astonishing $47.4B.

AOL Merges with Time Warner Cable

This transaction is an excellent example of how macroeconomic conditions can influence the deal’s success. The deal between Time Warner Cable and AOL concluded in 2000, but the subsequent dot-com crash two months later was a huge setback.

The M&A transaction was valued at $325B by today’s standards but fell apart nine years later. Time Warner is known to have entered into another deal with AT&T for $108B, adjusted for inflation. The deal closed in 2018 but attracted flak from anti-trust authorities.

Walt Disney Company Acquires 21st Century Fox

Walt Disney acquired 21st Century Fox in 2017 in a $83.7B deal, adjusted for inflation. This deal is one of the most successful transactions in history. And enabled Disney to expand its foothold in the global entertainment industry. It has also added content diversity to its streaming product portfolio.

Disney now has a broader entertainment selection and direct-to-customer (D2C) streaming services. But the biggest advantage is combining top franchises like Dead Pool and the X-Men under one brand.

To Wrap Up!

Achieving financial synergies after an M&A transaction is, undoubtedly, the core objective of any deal. Dealmakers conducting due diligence are likely to estimate the value they can generate in terms of financial benefits.

These benefits can come from operational savings, higher debt capacity, and the ability to generate more equity capital. Whatever your strategies, if the financial synergies create wealth for the owners and stakeholders, that’s a win.

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