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Tap into the inorganic growth

Any living organism has to continue growing lest it begin to die. It is difficult to maintain a constant state of existence. In fact, in the absence of growth, it is more than likely that there will be shrinkage, deterioration, emaciation, or a tendency towards dying. Business enterprises, just like living organisms, also feed, rest, grow, and can as well fall sick and in extreme cases even die.

Management of any enterprise has the primary motive of maximizing returns for its sponsors/shareholders. It does this by trying to maximize revenues while at the same time minimizing related expenditure. Revenues are a consequence of volume production, sales, and pricing of the enterprise’s products/services whereas expenses can either be fixed (mostly overheads that remain the same at all levels of production) or variable (increasing with increase in production and operations).

Good management practice seeks ways of increasing efficiencies within the revenue and cost structure of the enterprise to grow both the sales revenues and profits. When installed production capacity is fully utilized, the next logical step is to increase capacity geared towards either more production of the same commodities/services or diversifying the product/service range as a result of research and development (R&D) endeavors, or both. The capacity increase could also be attained through investments in the value chain that may be done from scratch or by way of consolidation with existing player(s).

This increment in capacity can be financed using internal funds, external funds, or a blend of both. If it is achieved without diluting the shareholding structure of the enterprise or without the acquisition of another entity, then this growth is considered to be organic. This is usually the desired approach to growth as it creates minimum disruptions to the ownership, control and operational structures of the enterprise. However, organic growth - on its own - may not always be feasible.

The other option is inorganic growth through mergers and acquisitions (M&A). It carries with it some complexities, but it also brings many benefits to the enterprise if properly harnessed. The M&A option can be driven by the buyer (buy-side) or driven by the seller (sell-side), the former meaning that growth is realized through the acquisition of another entity and the latter through being acquired by another entity. It may also be a merger/amalgamation of two entities of comparable size. Inorganic growth can happen vertically (along the value chain, i.e. forward or backward integration) or horizontally (at the same level of the value chain).

Some of the advantages of inorganic growth include the benefits that come with an instant increase in economies of scale and scope; larger market share; enhancement of strategic outlook; operational synergies especially in vertical integration; rationalisation of talent and workforce; rationalisaton of distribution channels; increased competitiveness through the proliferation of internal efficiencies; R&D and refinement of go-to-market strategies; tax benefits especially when one of the entities in the transaction has significant tax losses brought forward; enhanced financial leverage of the merged entity; to mention but a few.

It is also worth noting that inorganic growth has its potential drawbacks some of which include the costliness of the exercise (if not properly managed); potential for cultural clashes and technological mismatches; potential for branding confusion; dilution of shareholding; retrenchments and attendant reputation risk; and diseconomies of scale.

Since growth is inevitable for survival, Management ought to engage an independent business advisor to assist in objectively exploring both organic and inorganic opportunities for growth. For the inorganic options, it is crucial to assess the readiness of the entity and its stakeholders and to proactively prepare the entity for robust and effective M&A. Management should explore the strategic rationale of the intended M&A, the targeted synergies and how these can be unlocked, reputational issues that may accrue, applicable regulatory framework, potential pitfalls and appropriate mitigations. Most importantly thorough due diligence, efficient structuring (tax, legal and operations) and proper valuation should be done before any such transaction can be implemented.

Inorganic growth is one interesting phenomenon that enterprises ought always to consider as they seek to survive, thrive and maximize shareholder returns, especially now as the economy recovers from the adverse effects of the COVID19 Pandemic.

The writer is a corporate and project finance specialist at Frontier Advisory Partners.

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