OPERATING AGREEMENT: WHAT IS IT & WHY EVERY BUSINESS OWNER NEEDS ONE! Starting a business is exciting, but it also involves important decisions and legal considerations. One crucial document that
Mergers: Outlining the Process of Combining Companies
The U.S. is home to over 32 million small businesses and thousands of large businesses. Many, perhaps even most, of these businesses will sink or swim on their own merits and only interact with other businesses as competitors.
Yet, from time to time, you see company synergies. Two businesses can, theoretically, benefit from combining their efforts. For example, a video game company with deep programming talent might benefit from combining with a gaming company that’s strong in marketing but weak in programming talent.
This is where mergers come into the picture. If you think your company could benefit from merging with another but aren’t sure what that entails, keep reading. We’ll provide an outline of the merger process.
What Is a Business Merger?
A business merger isn’t just a business process but a legal process as well. It happens when two companies, in essence, pool their resources and form a completely new legal entity.
Mergers can offer a lot of benefits to the business owners or companies involved. For example, an underfunded company with a strong product line can merge with a company that’s flush with cash but in want of new products. The new company benefits from the well of ready cash and a strong product line.
Mergers can also let businesses expand into new markets. For example, say there is a chain of Tex-Mex restaurants in northern Florida that wants to expand into the Miami area. Rather than compete with the existing businesses there, they might set up a merger with a chain of similar restaurants in the Miami area.
Before businesses merge, everyone involved wants to know that they aren’t getting sucked into someone else’s mess. For example, plenty of businesses have financial problems that aren’t obvious from the outside. Likewise, a business may possess assets that don’t contribute any real value or reduce the value of the business.
The due diligence process typically involves corporate or business lawyers, tax pros, and even bankers on both sides of the potential merger. These professionals will dig into a company’s financial statements, look for legal problems, check assets, and evaluate the business operations of both companies.
The point of the due diligence process is that it gives both sides a chance to expose any serious risk factors that might make the merger a bad call.
One of the other early steps involved in a merger is the valuation process. Valuation determines how much another company is worth. There are several potential ways of doing a business valuation. Some common approaches include:
- Discounted cash flow valuation
- Market value valuation
- Asset-based valuation
- Capitalization of earnings valuation
- Multiples of earnings valuation
Each approach offers certain strengths and weaknesses. For the purposes of a merger, however, the two businesses should agree in advance on which valuation method both will use. Otherwise, you end up with an apples-and-oranges situation.
Assuming both companies get through the due diligence process and valuation process and wish to proceed, they move on to negotiation. Negotiation can involve a lot of different elements but often focus on the status of management and employees post-merger.
After all, both businesses already have owners or senior management in place. Both businesses will likely also have admin staff in place, such as in their HR departments.
The negotiations typically specify who among the owners or senior management will assume what roles moving forward.
Small Business Merger
Let’s say that two small businesses merge. While both owners will retain an ownership stake and a claim on profits, someone must serve as the head of the business. In many cases, one person will take on a more CEO-like role, and the other will take on a COO role based on their own preferences.
For larger companies with senior management teams, a number of people will inevitably leave the company with a severance package. In terms of rank-and-file employees, the businesses may agree on a more general percentage of employees retained from each business with specific decisions left up to a transition team.
There is typically some kind of financing agreement put into place with mergers to compensate for inequalities between the businesses. If a larger business merges with a smaller company, the owner of the larger company may get additional stock or a cash payout.
After the merger, the new business will typically issue stock to all stockholders from old companies in an amount equal to the value of the stock they held. In some cases, the financing may also include money to buy out some stockholders.
Once the merger team finalizes all of the paperwork and the financing is in place, the businesses must actually merge. Businesses will often use a transition team to handle things like evaluating employees and handling asset management. For example, determining which assets to keep and which to sell off.
Other Merger Factors
While the process remains largely the same for small business mergers and corporate mergers, there are some extra factors to consider with corporate mergers.
For example, many corporations issue stock. When a merger takes place, much of the negotiating happens behind closed doors. Stockholders typically only hear about whatever information the companies make public.
In fact, negotiations often happen under strict non-disclosure agreements with large companies.
That can make stockholders edgy or even get them to dump their stock. That, in turn, can cause stock prices to plummet for one or both companies. On the other hand, if the market looks favorably on the merger, it can also cause stock prices to soar.
This uncertainty can make corporations cagey about merger talks. That is often even more true if the companies are only discussing the possibility and not engaging in active negotiations.
Mergers and You
Mergers can prove a complicated and time-consuming process, but they can also yield a lot of benefits. Mergers can improve market position, open new markets, and provide new resources to a struggling business unit.
The process is also sufficiently complex that most people will want some legal guidance along the way.
Venerable Law provides legal services to businesses in the Tampa area. For questions or more information about our services, contact Venerable Law today.
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