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What are the different types of synergies used in company valuation?

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One of the most important aspects of investment banking is company valuation, which is the process of estimating the economic worth of a business or a deal. There are many methods and techniques to value a company, but one of the most common and relevant ones is the synergy valuation. In this article, you will learn what are the different types of synergies used in company valuation, how they are calculated, and what are the main sources and drivers of synergies.

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Paras Doda

Investment Banking | Fundraising | Pitch Decks | Financial Modeling
Jeetain Kumar, FMVA?

I help students & executives in finance ? MBA (LPU)'24 ? 35k ? KPMG Certified Financial Consultant ? ESG & FP&A…
Matheus de Souza Barboza

E-commerce | Marketplaces | Finan?as | Estratégia | Consultor | Conselheiro | C-level | Valuation

1 What is synergy valuation?

Synergy valuation is the concept that the value of a combined entity is greater than the sum of the values of its individual parts. In other words, synergy valuation implies that two plus two equals five, or even more. Synergy valuation is often used to justify mergers and acquisitions, as it reflects the potential benefits and cost savings that the deal can generate for the shareholders of both companies.

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Paras Doda

Investment Banking | Fundraising | Pitch Decks | Financial Modeling
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Cost Synergies: Savings achieved by combining operations, reducing duplicate expenses, and streamlining processes. Revenue Synergies: Increased revenue opportunities resulting from expanded market reach, cross-selling products, or leveraging complementary customer bases. Financial Synergies: Improved financial performance through better access to capital, reduced borrowing costs, or enhanced creditworthiness. Strategic Synergies: Enhanced competitive advantage or market positioning achieved by combining complementary resources, technologies, or capabilities. Operational Synergies: Efficiency gains from combining operations, sharing expertise, or leveraging best practices.

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Jeetain Kumar, FMVA?

I help students & executives in finance ? MBA (LPU)'24 ? 35k ? KPMG Certified Financial Consultant ? ESG & FP&A Specialist
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As a Finance Professional, Synergy valuation involves assessing how the combined value of merged entities exceeds the sum of their values. It's a critical aspect in mergers and acquisitions, demonstrating potential benefits beyond mere arithmetic addition. By identifying synergies, companies can justify deals based on increased efficiencies, cost savings, and enhanced market positioning, thereby creating additional value for shareholders.

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Matheus de Souza Barboza

E-commerce | Marketplaces | Finan?as | Estratégia | Consultor | Conselheiro | C-level | Valuation
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Os principais tipos de sinergias utilizados na avalia??o: Sinergia Operacional Sinergia de Receita Sinergia de Custos Sinergia Financeira Sinergia de Impostos Sinergia de Impostos Sinergia de Marca Sinergia de P&D (Pesquisa e Desenvolvimento) Sinergia de Talento

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Rohit Kumar Sharma

Sr. Equity Research Analyst | HNI Client dealing | Portfolio Management | Twitter ?? Rkgemi
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Synergies are the additional value that can be realized by combining two or more enterprises. There are various forms of synergy utilized in business valuation: Cost synergies, are generated by lowering unnecessary expenses or enhancing operational efficiency. Revenue Synergies,When two companies join, they earn more revenue together than they would separately. Market synergies emerge when a merged business gets a competitive advantage or market power. Strategic synergies result from overlapping business strategies and competencies. Financial synergies result from the combination of financial resources. Operational synergies are increases in efficiency and effectiveness that result from integrating processes, systems, and resources.

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2 What are the types of synergies?

There are two main types of synergies: revenue synergies and cost synergies. Revenue synergies are the increases in sales or market share that result from the combination of two businesses. For example, revenue synergies can arise from cross-selling, product diversification, market expansion, or pricing power. Cost synergies are the reductions in expenses or investments that result from the elimination of redundancies or inefficiencies. For example, cost synergies can arise from economies of scale, operational integration, headcount reduction, or asset optimization.

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Markus Buchner

?? Professor, Vice Dean of Business School Pforzheim | ?? M&A and Valuation Expert
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Synergies can be distinguished by several factors, e.g.,: - strategic (new sales market opens up) vs. operating synergies (consolidation of business activities) - revenue (increased sales prices and quantity) vs. cost (lower purchase prices, cost degression) vs. finance synergies (better rating, better capital market access, favourable cross-border tax structuring, utilization of tax losses) Synergies are typically connoted positively (see above), but can have negative consequences as well (e.g., culture-clash post-transaction).

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3 How are synergies calculated?

The calculation of synergies depends on the type and source of the synergies, as well as the assumptions and projections made by the analysts. However, a general approach to estimate synergies is to compare the combined pro forma financial statements of the merged entity with the standalone financial statements of the individual companies. The difference between the two scenarios represents the value of the synergies. Alternatively, synergies can be calculated as a percentage of revenue, cost, or EBITDA, based on industry benchmarks or historical data.

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Markus Buchner

?? Professor, Vice Dean of Business School Pforzheim | ?? M&A and Valuation Expert
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Depending on the type of revenue, revenue synergies may be planned as additional sales, whereas cost synergies are reflected in lower cost line items (e.g., lower purchase prices lead to lower COGS). All this can be incorporated in a valuation method, which leads to the upper price limit of the buyer. Related to the valuation of synergies is the control premium, that is empirically observable in M&A deals.

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4 What are the sources of revenue synergies?

Revenue synergies can be achieved through various sources, which depend on the nature and strategy of the deal. Cross-selling, product diversification, market expansion, and pricing power are some of the most common sources. Cross-selling enables companies to sell complementary products or services to existing customers, thereby increasing customer lifetime value and retention rate. Product diversification allows companies to offer a wider range of products or services to the target market, thereby attracting new customers and enhancing their competitive advantage. Market expansion enables companies to enter new geographic or demographic markets, either organically or through existing distribution channels, thus increasing their market share and penetration. Lastly, pricing power allows companies to charge higher prices or reduce discounts due to reduced competition or increased brand recognition, thus increasing their profit margin and revenue.

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5 What are the sources of cost synergies?

Cost synergies can be derived from various sources, depending on the nature and strategy of the deal. Economies of scale, operational integration, headcount reduction, and asset optimization are some of the most common sources of cost synergies. Economies of scale refer to the reduction in average cost per unit due to increased output or volume, thereby improving operational efficiency and profitability. Operational integration involves consolidating or streamlining business processes, systems, or functions to reduce complexity and duplication. Headcount reduction entails eliminating or relocating overlapping or unnecessary staff to reduce labor cost and overhead. Lastly, asset optimization is about rationalizing or utilizing physical or intangible assets to reduce capital expenditure and depreciation.

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6 What are the drivers of synergies?

The drivers of synergies are the factors that influence the magnitude and timing of the synergies. The drivers of synergies can vary depending on the type and source of the synergies, but some of the most common drivers include strategic fit, industry dynamics, regulatory environment, and execution risk. Strategic fit refers to the degree of alignment or compatibility between two companies' visions, missions, goals, and cultures. Industry dynamics looks at trends, opportunities, threats, and competition in an industry or sector. Regulatory environment considers laws, rules, policies, and standards in an industry or sector. Execution risk looks at potential challenges or difficulties that may arise during a deal process or post-merger integration. All of these drivers affect the success of a deal and the realization of synergies.

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Matheus de Souza Barboza

E-commerce | Marketplaces | Finan?as | Estratégia | Consultor | Conselheiro | C-level | Valuation
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Sinergia de Talento Defini??o: Refere-se ao benefício de reter e atrair talentos valiosos de ambas as empresas combinadas. Exemplo: Aproveitamento da expertise e habilidades dos funcionários de ambas as empresas para impulsionar a inova??o e o crescimento.

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Matheus de Souza Barboza

E-commerce | Marketplaces | Finan?as | Estratégia | Consultor | Conselheiro | C-level | Valuation
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Sinergia de P&D (Pesquisa e Desenvolvimento) Defini??o: Resulta da combina??o de recursos e conhecimentos em P&D para impulsionar a inova??o e o desenvolvimento de novos produtos. Exemplo: Compartilhamento de patentes, tecnologias e expertise em P&D para acelerar o desenvolvimento de produtos inovadores.

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Matheus de Souza Barboza

E-commerce | Marketplaces | Finan?as | Estratégia | Consultor | Conselheiro | C-level | Valuation
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Sinergia de Marca Defini??o: Envolve o fortalecimento ou amplia??o da presen?a da marca resultante da fus?o ou aquisi??o. Exemplo: Aproveitamento da reputa??o ou reconhecimento de uma marca para melhorar a imagem da empresa combinada, aumentando sua participa??o de mercado.

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What are the different types of synergies used in company valuation?

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1 What is synergy valuation?

2 What are the types of synergies?

3 How are synergies calculated?

4 What are the sources of revenue synergies?

5 What are the sources of cost synergies?

6 What are the drivers of synergies?

7 Here’s what else to consider

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