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What is Merger and How to Merge a Small Business?

Preeti Verma — Thu, 04 Feb 2021 10:35:02 +0000

Growth is an essential fuel to run a successful business. Of course, there are other things too that help a business to grow. And sometimes this growth is effectively brought in by channelising the organisation’s capital into various assets in a step-by-step manner, both internally and externally through merger. The internal growth of an organisation takes place through the acquisition of assets and after financing them from external sources or through the retention of earnings. While external growth can be brought through the acquisition of another company.

The term merger means amalgamation or combining of two or more business organizations to form a separate entity. This process leads to the dissolution of two or more entities, where both get absorbed into another undertaking, and as a result, the outcome becomes relatively bigger in size like assets, capital and human capacity. It is a strategy adopted by the company to maximise company’s growth by expanding its production and marketing operations, that results in synergy, increased customer base, reduced competition, introduction to a new market/product segment, etc. On the same side, the shareholders of the old company also get their part of ownership in the new company. Here, the surviving organisation acquires the assets, liabilities, personnel and much of the reputation of the fusing company.

However, a merger is fundamentally different from a statutory consolidation. As it involves a combination of two companies, whereby an entirely new corporation is formed. Both the old companies cease to exist, and the shares of their common stock are exchanged for shares in the new company. When two companies of about the same size combine, they usually consolidate. But when two companies differ significantly in size, then they usually merge. Though mergers are not common, they have a market effect, whenever they do occur.

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The perfect marriage between a man and a woman is considered to be a match made in heaven.” So is the commitment companies make in a merger.

Many psychologists and economists have explored metaphors for the logistical, emotional and financial realities for companies in a merger. Mergers and matrimony go hand in hand. Like a marriage vows, two companies make a permanent commitment to move forward together to build a new future. Similarly like a successful marriage, a successful merger makes a whole that is greater than the sum of its parts, and involves compromise on both sides to iron out details and communicate effectively. Likewise, the marriage analogy manifests itself in buzz phrases: “The perfect marriage between a man and a woman is considered to be a match made in heaven.” So is the commitment companies make in a merger. It is serious and an apt set of observations.

Types of Mergers

A conglomerate merger is between companies that are totally not related and operated in distinct markets. There are two types — pure conglomerate and mixed conglomerate. A pure conglomerate merger includes companies that have nothing in common between them. On the other hand, a mixed conglomerate merger involves companies that are looking for expansion in business, such as an extension of products to different geographical locations or development of new products. However, the biggest risk in a conglomerate merger is the immediate shift in business operations, as the two companies operate in completely different markets and offer unrelated products or services. For example, Walt Disney Company and the American Broadcasting Company underwent a conglomerate merger. Walt Disney Company is an entertainment company, while American Broadcasting company is a US commercial broadcast television network.

A horizontal merger refers to a business consolidation that occurs between entities that operate in the same industry. These are generally done to increase market share, further utilize economies of scale, and exploit merger synergies. Competition is usually higher among corporates operating in the same space. It means that the synergies and potential gains in market share are much more significant for entities merging. A horizontal merger often occurs because of more prominent companies trying to build more efficient economies of scale. A famous example of this type can be Hewlett-Packard (HP) and Compaq in 2011. The successful merger between these two companies created a global technology leader valued at over $87 billion.

A market-extension merger is between companies that sell the same products or services but operate in different markets. The goal here is to gain access to a larger market and thus a bigger client or customer base. The main benefit of this type of merger is to give the companies that merge a larger market reach and client base as a result of its new capacity. The merger in 2002 of the American-based Eagle Bancshares Inc by the subsidiary of Royal Bank of Canada, RBC Centura Inc. This large acquisition saw the Canadian company gain access to Eagle Bancshare’s assets, which were worth $1.1 billion, as well as almost 90,000 accounts. Eagle Bancshares owned Tucker Federal Bank is one of the biggest banks in Atlanta with over 250 workers.

A vertical merger is between companies that operate along the same supply chain. It is the combination of companies along the production and distribution process of a business. The rationale behind a vertical merger includes higher quality control, better flow of information along the supply chain, and merger synergies.

A notable vertical merger happened between America Online and Time Warner in 2000. Each company had different operations in the supply chain – Time Warner supplied information through CNN and Time Magazine, while AOL distributed information through the internet.

A product extension merger refers to a situation where two businesses who operate in the same market and offer products or services which are not the same but are often co-consumed decide to come together. The benefit is that the companies are able to create a meta product from their individual products and access a larger market. Pooling resources ensures that their cost of operations is reduced and profits are increased. By employing a product-extension merger, the merged company is able to group their products together and gain access to more consumers. It is important to note that the products and services of both companies are not the same, but they are related. The key is that they utilize similar distribution channels and common, or related, production processions or supply chains. Mobilink Telecom Inc. and Broadcom underwent a product-extension merger. The two companies both operate in the electronics industry and the resulting merger allowed the companies to combine technologies and enable the combination of Mobilink’s 2G and 2.5G technologies with Broadcom’s 802.11, Bluetooth, and DSP products. Therefore, the two companies are able to sell products that complement each other.

Merging a Small Business

Combining forces with another business can be a daunting task for either a CEO of a large multinational or for a solopreneur. From making sure that the company cultures are compatible with each other, to sorting out the leadership structure of one’s new enterprise, it seems there is no end to the tasks that must be completed. Amalgamating two or more businesses into one business is a common way to improve the performance of each individual business by capitalizing on the benefits each company provides, and utilizing the common resources available to all companies after the merger. At the time of merging two or more businesses, there are several things that need to be considered before the merger process can take place.

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Amalgamating two or more businesses into one business is a common way to improve the performance of each individual business by capitalizing on the benefits each company provides, and utilizing the common resources available to all companies after the merger.

Before taking the merger process ahead, the structure of each firm needs to be examined properly to determine the best procedure for merging with the business. Always compare and analyse the corporate structures for better outcomes. Take into account the many perspectives while preparing the legal structure of the merger. After the structural details of the proposed merged organization are sorted out, the leadership structure of the future company needs to be established.

Acknowledging the branding of the new company takes center spot post-merger. Pay close attention to how one wants to market the new company. A careful analysis of the balance sheets of the merged companies must be undertaken well in advance, as this can make or break the merger deal. Before proceeding too far with the merger process, perform due diligence on the potential merger.

Importance of Merger

Synergies

Synergy refers to the greater combined value of merged firms than the sum of the values of individual units. It is something like one plus one more than two. It results from benefits other than those related to economies of scale. Operating economies are one of the various synergy benefits of merger or consolidation. The other instances, which may result in synergy benefits include, strong research and development facilities of one firm merged with better organised production facilities of another unit, enhanced managerial capabilities, the substantial financial resources of one being combined with profitable investment opportunities of the other, etc.

Diversification

Two or more companies operating in different lines can diversify their activities through amalgamation. Since different companies are already dealing in their respective lines there will be less risk in diversification. When a company tries to enter new lines of activities then it may face a number of problems in production, marketing etc. When some concerns are already operating in different lines, they must have crossed many obstacles and difficulties. Merger will bring together the experiences of different persons in varied activities. So, amalgamation will be the best way of diversification.

Increasing the Value

One of the main reasons for merger is the increase in value of the merged company. The value of the merged firm is greater than the sum of the independent values of the merged companies. Let’s say, if A Ltd. and B Ltd. merged and formed C Ltd., then the value of C Ltd. is expected to be greater than the sum of the independent values of A Ltd. and B Ltd.

Reducing Competition

The merger of two or more companies will reduce competition among them. The companies will be able to save their advertising expenses, and enable them to reduce their prices. The consumers will also benefit in the form of cheap or goods being made available to them.

Proper Financial Planning

The companies after merger can plan their resources in a proper way. The collective finances of merged companies will be more and their utilisation may be better than in the separate concerns. It is likely that one of the merging companies has a short gestation period, while the other has a longer gestation period. The profits of the company with a short gestation period will be utilised to finance the other company. When the company with a longer gestation period starts earning profits then it will improve financial position as a whole.

Economic Necessity

Economic necessity likely to force the merger of some units. If there are two sick units, the government may force their merger to improve the financial position and overall working. A sick unit may be required to merge with a healthy unit to ensure better utilisation of resources, improve returns and better management. Let’s say, from time to time the Indian government has merged Navratna Public Sector Enterprises.

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All You Need To Know About Exchange Rate

Aakash Sharma — Mon, 04 Jan 2021 07:26:13 +0000

Exchange rate lets you know how much your money is worth in another country.

Whether you’re planning to start a business that involves international trading or are planning on travelling abroad, one thing that you will primarily come across is the term ‘exchange rate’. Naturally, you would want to know what is an exchange rate, why is it needed and how does it impact you. Well, let’s find out.

The exchange rate is the “price of one currency in terms of another currency”, meaning that it is the value of a country’s currency for the purpose of conversion to that of another nation or economic zone. For example, according to the latest exchange rate, 1 United States Dollar equals 74.27 Indian Rupees ($1 = Rs 74.27)

Now the question arises, How is exchange rate calculated?

Since the it is a conversion method for currencies of different countries of the world, there are different methods that are used by different countries for calculation. The following segment can also be read as the types of exchange rates on the basis of calculation methods.

Exchange rates are calculated in the following ways:

Free-floating or Flexible

A free-floating, also known as flexible or fluctuating, exchange rate is a type of exchange rate system in which the value of a currency is measured in terms of the foreign exchange market, commonly known as forex short for foreign exchange. Forex is a global marketplace that determines the exchange rate for currencies around the world. Participants in this marketplace buy, sell, exchange, and speculate about their respective currencies.

In this system, the rate of exchange can rise or decline based on economic factors, including the strength of a nation’s overall financial health. Hence, the flexible exchange rate can change on a daily basis. A country that uses a floating exchange rate is called to have a floating currency. The most prominent example of a floating currency is the US Dollar.

The floating exchange rate is considered as the best possible system since it automatically adapts to economic conditions of a country as well as the foreign exchange market. This exchange rate system allows countries to reduce the impact of shocks in the international financial markets and help prevent a balance of payments crisis. However, as a result of their dynamism, free-floating exchange rates are not useful for predicting exchange rates.

For example, an American dollar might buy 1 British Pound today, but it might buy only 0.95 pounds tomorrow, therefore, indicating the free-floating value of the exchange rate.

Fixed or Pegged

A fixed exchange rate is one at which a country fixes its currency value relative to an entity such as gold or another currency. Although most countries estimate their currency differences based on the foreign exchange market, some countries control the exchange rate of their currencies relative to other currencies. This simply is referred to as the fixed exchange rate. It is also known as a country ‘pegging’ its currency to that of another nation, hence ‘pegged exchange’ rate.

Fixed rates maintain a “stable” rate by controlling how much a foreign currency is worth. This system of the exchange rate is periodically adjusted and fixed in accordance with the state of the entity against which they measure their currency. Different governments maintain different rationales for maintaining a fixed exchange rate.

For example, the Hong Kong dollar is always pegged against the US dollar in the range of 7.75 to 7.85. Or, if you go to Saudi Arabia, 1 US dollar will always buy you 3.75 Saudi Riyals as the exchange rate is fixed.

Some countries even have restricted currencies, limiting the exchange rate within the country’s borders. The government can set a limited price for a restricted currency. For example, Brazilian Real is considered to be a restricted currency as Fund transfers in this currency cannot be sent outside of Brazil. This leads to a limitation of trade in a currency.

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The US Dollar is the most widely used reserve currency in the world; more than 60% of the central bank's foreign exchange reserves around the world are stored in US Dollar.

Onshore Vs. Offshore

Exchange rates can vary within a country itself. In some countries, the exchange rates system comprises of onshore and offshore exchange rates. Onshore exchange rates are applied domestically, while offshore currency exchange rates apply to foreign trade transactions.

The difference between onshore and offshore exchange rates is that onshore exchange rates are controlled by a country’s central bank (restricted currencies), while offshore exchange rates are almost entirely determined by forex. Generally, a more favourable exchange rate can often be found within a country’s border versus outside its borders.

For example, China is a major country with this exchange rate structure. Chinese currency Yuan is a government-controlled currency. In the case of Yuan, onshore exchange rate transactions are strictly controlled by the People’s Bank of China, and overseas transactions are freely traded according to forex standards.

Spot and Forward

Exchange rates too have a rate called the ‘spot rate’, which is indicative of the cash value of the currency in the current market. Alternatively, an exchange rate also has an expected value, which is called ‘forward rate’. The forward rate is based on the expectation that the value of the currency will rise or against its spot price in future. Forward rate values may fluctuate due to changes in expectations for future interest rates in one country versus another.

For example, let’s say that traders have the view that the US will ease monetary policy for India. In this case, traders could buy the Indian Rupee versus the US Dollar, resulting in the value of the US Dollar falling.

Why do you need to know about exchange rates?

Before undertaking any task that involves international transactions, whether it is business, export or travelling, you need to have a clear understanding how the exchange rate system of your country as well as the country you want to undertake the activity in works. The rate lets you know how much your money is worth in another country.

It helps you in financial budgeting of your prospective business or other plans. Moreover, an understanding of exchange rates can help you get the best deals on currency conversion before you convert your currency into foreign money.

The exchange rate plays an important role in international trade and investment as well. For example, if the US dollar rises in value than the Euro, Americans trading with Europe will have an upper hand in the purchasing power, while it will become harder for European companies to export goods to the US.

What impacts an exchange rate?

The US Dollar is the most widely used reserve currency in the world; more than 60% of the central bank’s foreign exchange reserves around the world are stored in US Dollar. The country’s central bank stores reserves to facilitate business and financial transactions. These reserves are subject to a country’s economic strength, which in turn, is measured by the Gross Domestic Product (GDP) and numerous financial and trade instruments. And economic conditions of the world, especially of the developed countries like the US and the European Union, have a major impact on the exchange rate used around the world.

Fluctuations in the exchange rate are highly dependent on a wide range of factors, such as interest rates, price levels, geopolitical safety concerns, and expected future market conditions. Some of these factors are explained below.

Interest Rates

A change in the interest rate on money borrowed or lent by a country affects its currency value and exchange rate significantly. A rise in interest rates leads to an increase in the country’s currency value, as higher interest rates give higher rates to lenders, thus attracting more foreign capital and leading to an increase in exchange rates.

Inflation Rates

Volatility in market inflation rates causes changes in exchange rates of a country’s currency. A country with a lower inflation rate sees an increase in the value of its currency, whereas a high inflation rate in a country depreciates the value of its currency. Therefore, lower inflation rates result in a higher valuation of currency and strengthen its exchange value.

Government Debt

Government debt is a national debt owed by the national government to financial entities. If a country has massive government debt, it is less likely to receive foreign capital and have much higher inflation rates. This can lead to flooding of the country’s market with foreign investors selling their stakes in the open market, creating the case of excessive supply and no demand. Thus, the currency value will drop significantly and the country’s exchange rate will fall.

Political Stability

The political position of a country severely affects the strength of its currency. Countries that are less at risk from political unrest are more attractive to foreign investors, attracting more foreign investment. Foreign capital increase leads to the increment in the valuation of a country’s currency. Countries with solid monetary and commercial policies promise great returns to investors and this significantly affect the country’s currency exchange rate.

Recession

If a country has a delicate economy that shows grave signs of economic recession, i.e., reduction in GDP growth rate for three consecutive quarters, it loses decreasing large foreign capital investments. As a result of this, the currency of the country weakens and the exchange adversely lowers.

Expected Market Speculations

If a country is estimated to witness growth in its currency value, investors acquire more and more of that country’s currency with the hopes of massive profit in future. Subsequently, the value of the currency increases with the increase in demand. And therefore, the exchange rate of the currency increases as well.

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It is a conversion method for currencies of different countries of the world, there are different methods that are used by different countries.

It is, therefore, clear that the exchange rate of a country’s currency is not only a key determinant of a country’s relative level of economic health, it also holds much importance for prospective business owners and individuals who aim to reach the global heights of success. The valuation of a currency, driven by numerous factors, makes a country’s imports and exports competitive in the global market, thereby, giving businesses across the global spectrum a chance for growth and profit.

They also play an important role in Foreign Direct Investment (FDI), i.e., the investments made by business entities into companies, projects and businesses located in different countries across the world through various capital assets and formats.

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