Business mentor: Mergers often the smart, brave option

Q: My business is struggling. We operate in a growing market, have good products and reasonable increases in sales volumes, but our profits are static. I know one of our competitors, which is about the same size as us, is also feeling the strain. I've read about businesses merging but it's normally the bigger corporates. Would a merger be an option for a smaller business?


* Tim Downes, a director of Cobalt Partners, corporate development specialists, replies:

A: New Zealand has a small economy and a high proportion of small and medium-sized enterprises (SMEs) battling for a share of a small market. Under these circumstances, it's not surprising most SMEs struggle to provide their owners a return greater than what they might reasonably expect to earn from being employed by someone else.

These companies seldom generate an investment return to their owners for the risk of having their capital tied up in their business, over and above a fair reward (wage) for their effort and skill.

In some circumstances, the key to better returns lies in the merging of two or more of these SMEs into a single business. However, the initiation of this process can be difficult for a SME owner.

Typically, an SME only gets started through the determination and self-esteem of the owner. Making an approach to an erstwhile competitor to discuss the logic of a merger is often perceived as a sign of weakness when, in fact, it's just being smart and brave.

The primary options for an SME manager are to concentrate on organic growth and cost savings or to increase market share through an acquisition of, or merger with, a competitor.

Interestingly, mergers of large corporates often lead to a decrease in shareholder value. This is due to those mergers often being carried out for non-commercially logical reasons such as satisfying the ego of the CEO.

For SMEs, the rationale for a merger is normally much more clear cut.

So when does a merger make sense? Assuming an SME has a good product or service for which there is reasonable customer demand, the chances are it could have a viable business. However, the competitive landscape for the business could be such that it is always likely to struggle in spite of having a few things going for it. The problem is that a certain minimum level of sales needs to be achieved each month to cover monthly overheads.

This will be the same for the business' competitors and they might be equally concerned about putting out signals that they are struggling. But what would happen if the two competitors combined?

There may be a need for only one premise's rental, one set of administration costs and potential savings in a lot of other areas.

There may also be more money left over each month for better marketing and advertising and to employ better-qualified staff.

How do we approach our competitor to suggest a merger?

Sometimes an intermediary can be useful to make the initial approach and to assist with merger negotiations. Other times, a direct approach by the SME may be best.

In any event, it would be worthwhile for any SME considering a merger to obtain assistance from a suitably qualified independent party at some stage to get a second opinion of the robustness of the case for a merger and to assist in the valuation and negotiation process.

* For more information contact Tim

Answers are courtesy of Sarah Trotman of Spring Group.

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