What are synergies in M&A?

Synergies are the additional value created when two companies combine, compared with operating separately. They are a major reason strategic buyers can pay more than financial buyers.

There are two main kinds. Cost synergies come from eliminating overlap: combining head offices, closing duplicate facilities, merging IT systems and negotiating better terms with suppliers thanks to greater scale. Revenue synergies come from selling more: cross-selling each company's products to the other's customers, using a larger sales network or gaining pricing power. Cost synergies are considered more reliable because management controls them, while revenue synergies depend on customers and competitors and often take longer, so investors and buyers usually discount them heavily.

In a model, I phase synergies in over two or three years rather than assuming they arrive on day one, and subtract the one-time integration costs needed to achieve them, such as severance and system migrations. The present value of net synergies tells the buyer the most extra premium it could pay before the deal destroys value. In practice the buyer wants to keep a good share of that value, so how much of the synergies get paid away is a central negotiating point.