Blog by Ben Greenberg, VP of Corporate Development at IT Solutions
If you’re considering M&A initiatives or navigating the challenges of growing your MSP, we invite you to explore our M&A resources.
By definition, a synergy is the potential benefit that arises from combining two or more businesses or assets. You may also hear this referred to as “2 + 2 = 5.” In the context of M&A, synergies are often what creates the value of a company undertaking a growth strategy. Although the term synergy often becomes synonymous with headcount reduction, this is far from reality, especially in a service-oriented business like a managed service provider (MSP). For most businesses, synergies can be classified into two major categories: revenue synergies and cost synergies. Let’s take a closer look at both.
Revenue (or growth) synergies are the additional revenues that can be generated by combining the products, services, markets, or customers of the two companies. Revenue synergies can result from cross-selling, upselling, bundling, market expansion, or innovation. Here are two examples in the MSP space:
As a point of caution, revenue synergies look good on paper but are often more challenging and take longer to achieve than expected. For this reason, sophisticated buyers will rarely bake in revenue synergies into valuation/return models. However, it is still wise to consider these upsides when developing a deal thesis, setting reasonable targets and tracking accordingly.
Cost synergies are the savings that can be achieved by reducing the combined operating expenses of the two companies. Cost synergies can result from newfound operational efficiencies, economies of scale, or rationalization. By way of example:
Although cost synergies are more reliable than revenue synergies, they should still be assessed conservatively. It’s ideal to track opportunities for cost synergies throughout the diligence process to ensure their footprint in the overall integration plan.
Not only is this a word that I’m never sure I’m spelling right, but it can also be a source of frustration in any M&A deal. Dyssynergies are adverse effects of the integration that reduce the combined performance or increase the cost structure of the merged entities. Dyssynergies can arise from various sources, such as losing key talent, customer attrition, or employee-related cost step-ups under new ownership. Dyssynergies are often overlooked or underestimated in the pre-deal analysis, as acquirers tend to focus on the positive aspects of the deal. However, dyssynergies can significantly impact post-acquisition results and should be accounted for in valuation and integration planning.
It should be noted that although dyssynergies have a negative immediate impact on the overall financial models, they can sometimes have a positive impact elsewhere. For example, if the acquiring company has higher employee benefits costs per employee, it will likely result in an enhanced benefits program for the acquired employees, which may help offset employee turnover.
Despite the attractive potential of synergies, most transactions fail to meet their synergy expectations. There are several reasons why synergy capture can be challenging, such as:
To overcome these challenges, acquirers need to adopt a rigorous, disciplined, and holistic approach to synergy capture, starting from the deal thesis and continuing throughout the diligence and integration process. Acquirers who are successful will identify, quantify, validate, prioritize, and track the synergies with clear lines of accountability. By doing so, acquirers can increase the likelihood of achieving or exceeding their synergy expectations and create lasting value from their transactions.
Embarking on a journey of growth, whether organically or through M&A, is both exciting and challenging. If you’re evaluating M&A initiatives or considering how to drive growth, we invite you to check out our resources and explore how we can support your MSP.
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