How does an Acquisition Lead To Growth of Business?
Generally, corporate restructuring activities like mergers and acquisitions are carried out to realize economic gains. For justification of such transactions, the combined worth of the two firms must be more than individual worth of each. A few potential benefits of an acquisition include realization of economies of scale, tax advantages, and elimination of inefficiencies as well as combination of complementary resources.
Apart from these, there are several other benefits of an acquisition. These include revenue enhancement, cost reduction, lesser taxes as well as change in capital requirements. An increase in revenue is generally caused by strategic benefits, market power and marketing gains. Strategic benefits correspond to the opportunities of entering new business lines. Marketing gains take place due to effective advertising, an improved product mix and economies of distribution. Moreover, an acquisition might reduce competition, which leads to an increase in market power.
A bigger firm might be capable of operating in a more efficient manner as compared to two small firms, this reduces costs. Moreover, economies are realized when two firms possess complementary resources. For instance, a particular firm has a surplus production capacity while its counterpart has inadequate capacity.
Tax advantages are also realized in acquisitions when the target firm carries the assets at prices lower than their market values. Therefore, for tax purposes, the assets can be more valuable if they owned any other organization. This increases the tax basis after an acquisition. Moreover, the acquiring company would depreciate the assets on the basis of higher market values leading to additional benefits.
The payment of interests on debt is a tax-deductible expenditure while the payment of dividends from equity ownership is not. Though the utilization of financial leverage leads to tax benefits, debts also increase the possibility of financial distress if the acquiring firm is unable to meet the interest payments on acquisition debts. Besides this, a firm having surplus funds might intend to take over another firm. This is because the distribution of money in the form of dividends or the use of money or repurchase of shares would increase the income tax for shareholders. During an acquisition, income taxes are not paid by the shareholders.
Additional benefits of an acquisition include improving the market power through purchase of competitors, acquiring proprietary rights to services or products, compensating for the weaknesses in key areas of business as well as penetration of new geographical regions.