Synergies 101
A dive into the different types of synergies, so you can use them to get a better price from your buyer.
Synergies. One of the most over-used and poorly understood pieces of jargon in M&A...
When negotiating the sale of your company, synergies can significantly drive up the price.
Let's understand what synergies are and the different types (with examples), so you know where to find them as you look for leverage in negotiations with a buyer.
What are synergies?
Synergies are benefits that two companies get when they combine after the deal.
That includes increasing revenue by integrating products or selling to each other's customers, or merging teams to save costs.
Why do synergies matter?
In a synergistic deal, your buyer can see ways to improve the profitability of your business or their own (or both).
This enhanced performance means they will pay more than a buyer without synergies.
If the synergies are large and credible, a buyer might pay a significant "Strategic Premium" – an amount over the objective market value of the company that a buyer without any synergies might pay.
If you are a small company being acquired by a large one, often the synergy value of improving the buyer's huge business can be greater than your standalone financial performance.
As a seller, finding a buyer with strong synergies who is willing to pay this premium is a key lever to increase your price.
Some simple maths
Let's run through some numbers that show how impactful synergies can be:
You are selling your company, which makes £3m of EBITDA per year. At the time, the going rate for valuation multiple for businesses of your size and growth rate in your industry is 8-10x EBITDA. So you are looking at an exit around £24-30m... and the buyer is of course pushing for the lower end of that range.
But you and the buyer work on quantifying some synergies. You believe there are ways to cross-sell your products which could deliver £400k a year of additional EBITDA, and some cost-saving initiatives which could deliver £300k a year of additional EBITDA.
That moves the EBITDA to £3.7m, and so, using the same multiples again, your exit range jumps to £30m to £37m.
The final price will depend on the specifics of the negotiation, but you have significantly moved the goalposts for the deal. Even if you end up at the bottom of the new range – that's £30m instead of £25m – you've added £5m of deal value in a few weeks of work.
Let's explore the types of synergies and some specific examples.
Types of synergies
Synergies can be grouped into three types:
- Revenue synergies (selling more)
- Cost synergies (saving money)
- Financial synergies (improving financial metrics)
To bring these to life, we'll use our fictional example of Legal Whizz. Legal Whizz sells software to UK law firms who use the product to build training sessions, courses and quizzes for their lawyers and new joiners.
They are in negotiations to be acquired by Scribe, the market leader in document management software for law firms. Scribe is excited to broaden its product portfolio by offering an exciting new training solution to its customers.
1️⃣ Revenue Synergies
Revenue synergies arise when the combined companies can increase sales from what they would sell separately.
Everyone loves growth, so these are the most exciting and most valuable type of synergy, but they can be hard to achieve in practice.
Here are the main examples, from most to least valuable.
👉 Cross-Selling
One or both companies can sell their products to the other's customers.
This works best if the two companies sell different products to the same customer base. Both sales teams now have two products to sell to their customers, rather than just one. They can bundle them together as one package, or just sell them separately.
The Scribe sales team can now pitch all of their customers on Legal Whizz (if they don't have it already), and perhaps offer special deals for buying both products together. Legal Whizz can also do the same by selling Scribe to their customers.
Or imagine a large advertising agency buying a small website hosting company. Now they can sell their clients a web hosting package at the same time as a website re-build.
👉 Product integration
A combined product, where the buyer and the target's products are joined into one or inter-operate, can sell better than standalone products.
Or perhaps the buyer has a gap in their product suite which is hurting their ability to close sales against the competition, and you can fill that hole for them.
This applies usually in technology companies, where clients value an integrated and complete solution rather than patching together different offerings from multiple providers.
The Legal Whizz training modules could be integrated into the Scribe document management system (so lawyers can see relevant training material as they are browsing through documents). This is an innovative feature which helps Scribe sell more of their product at a higher price.
👉 Sales expertise
This is a softer one. The sales and marketing know-how or brand power of one company (usually the buyer) can help to sell the target's product.
It's common for a start-up to have a good product but an inexperienced sales team or an unknown brand.
Scribe have been selling to law firms for 20+ years, and have some of the best sales and marketing people in the industry. They could help the Legal Whizz sales force to sell more effectively by sharing their playbooks and closing tactics. And being known as a division of Scribe, the trust and brand recognition will help the Legal Whizz sales teams sell more or increase prices.
👉 Market expansion
Often, the buyer can help the target company to expand into new markets more quickly or more effectively.
How? Because it has some assets in the market that the company is expanding into. That could be existing customers to cross-sell to (see above), some existing brand awareness or local expertise that could accelerate the launch.
Legal Whizz has plans to expand into the US market, and US growth is a large part of their forecast. Scribe has a small customer base in the US who could be initial customers for Legal Whizz, and an office in New York with a sales and marketing team with local market knowledge. These are small benefits, but will help Legal Whizz to scale its US business more quickly.
👉 Scale
In some consumer products, monetisation improves as you increase the scale of your audience or customer base. And conversely, it can be hard to monetise if you are below a certain scale or have a gap in your audience.
By merging the audiences of the buyer and seller, the larger combined audience can be better monetised for increased revenue.
This synergy doesn't apply to Legal Whizz. So as an example, consider a buyer with a portfolio of magazines for nurses which they monetise through ad partnerships. They are buying a niche publication for midwives, where they have an audience gap. Combined they have greater reach and cover a wider range of the profession, both of which advertisers pay a premium for.
👉 Pricing power
This is a controversial one. When two competitive businesses merge (see Horizontal M&A in The SIX strategies that drive M&A), the combined business will have greater market share and perhaps more pricing power.
This pricing power can be exploited to increase prices for both businesses.
The problem – this strategy is exactly why anti-trust regulators scrutinise Horizontal M&A. If this is your plan, there's a chance the deal gets blocked or that you'll be under close scrutiny afterwards.
You certainly shouldn't write 'pricing power synergy' in any documents or emails if there's a chance your deal needs anti-trust approval...!
2️⃣ Cost Synergies
Cost synergies are delivered when the combined companies can reduce their costs, usually by eliminating redundancies or improving efficiency.
These are typically quicker to achieve than revenue synergies, and much easier to quantify. And the savings comes straight off the bottom line.
But they can be tricky to implement, especially if that involves integrating teams with different cultures, or radically changing processes. The buyer needs experienced post-merger implementation teams (or consultants) to deliver these synergies.
👉 Headcount reduction
After an acquisition, you can reduce costs if two separate full-size teams are no longer needed in certain areas.
This can happen right across the organisation. Starting at the top – if the combined business only needs one CEO or CFO, the leaders of the target company can move on after the integration period, releasing some significant savings.
Other common ones are to merge are back office functions like HR and finance, plus sales and marketing and IT teams.
👉 Office and asset consolidation
Another simple one – the combined business can sometimes operate from a single office or can combine factories or logistics locations.
This can also be applied to other assets that might have some redundancy or spare capacity, like manufacturing equipment or server capacity.
👉 Improved supplier terms
Often, larger companies can often negotiate better terms with suppliers due to the higher volumes that they purchase.
So the target company can save costs by moving onto the buyer's cheaper terms. And the combined company could negotiate even better rates if the volumes increase significantly after the acquisition.
For lower gross margin businesses which are very sensitive to input costs, this can be significant.
👉 Supply chain efficiencies
Finally, you can achieve savings by improving procurement and logistics if one company can leverage its supply chain management skills to help the other.
That might increase delivery speeds, avoid stock shortages, reduce waste and improve inventory management. The work will be to consolidate suppliers, optimise routes or share distribution networks.
Imagine you are a small eCommerce business and get bought by a larger one with an established distribution capability and great inventory management processes – now you can offer faster or cheaper shipping or international shipping using their network, and reduce waste. All of which take cost out of the business.
3️⃣ Financial Synergies
Financial synergies occur when the buyer can improve the financial structure of the target, behind the scenes in the finance department. They can be more abstract and harder to quantify than revenue and cost synergies. So the CFO will be more excited than anyone else!
👉 Lower cost of capital
When the target joins a larger group, it may be able to borrow more cheaply using the improved credit worthiness of the buyer (if the buyer has a good credit rating or larger asset base it should have a lower cost of capital).
For example, if Legal Whizz can borrow more cheaply after the acquision to fund it's US launch, that will increase the forecast profitability of that business. If Scribe has excess cash on its balance sheet, it may choose to fund the launch without any external debt also.
👉 Tax benefits
Often the target company has accumulated tax losses which the buyer can use to offset future taxable profits, reducing the overall tax paid by the buyer's group.
👉 Improved cash flow management
If the buyer has excellent working capital management (control of receivables, payables and inventory) it can use these skills and processes to improve cash flow in the target, making it more financially robust.
How to find and prove synergies to your buyers
Here's the major problem with synergies – buyers often doubt they are genuine, likely to be achieved or as valuable as you say they are... or they pretend not to believe them as a negotiation tool.
Some M&A teams and CFOs can be hardcore cynics on synergies. A famous McKinsey survey found that 60% of synergy value never materialises post deal, and that stat is now well-known in the industry. So you have your work cut out to prove that there are some real, material synergies.
That can create a gap between what you believe is possible and what they will put in their valuation calculations, causing a price gap that’s hard to close.
There are some concrete methods to discover and quantify the synergies, so you get the price leverage that you want. There's a fair bit in that, so we've split that out into a separate piece (coming soon).