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External Growth

The growth of a company derived from using external resources and capabilities rather than internal business activities

What is External Growth?

External growth (also known as inorganic growth) is referred to as the growth of a company derived from using external resources and capabilities rather than internal business activities. External growth is the alternative to internal (inorganic) growth.

 

External Growth

 

The main advantage of external growth over internal growth is that the former provides a faster way to expand the business. However, organic growth is widely regarded as a better measure of a company’s performance than external growth.

 

External Growth Strategies

Companies may achieve external growth using two primary vehicles: mergers and acquisition (M&A) and strategic alliances. The main difference between the two categories is the change of ownership. M&A deals involve the complete exchange of ownership between the companies in the transaction. Conversely, a strategic alliance allows businesses to pursue their collective objectives while remaining independent entities.

 

1. Mergers and acquisitions (M&A)

Mergers and acquisitions refer to transactions between business entities that involve the complete exchange of ownership. A merger is a financial transaction in which two companies unite into one new company with the approval of the boards of directors of both companies. In a merger, the involved companies may create a completely new entity (under a new brand name) or the acquired company becomes a part of the acquiring company.

Conversely, an acquisition is a financial transaction in which the acquiring company (bidder) purchases a controlling stake in a target company. It can be done with the consent of the management and shareholders of a target company (friendly takeover) or without it (hostile takeover).

Generally, the M&A transactions can provide substantial benefits and growth opportunities to the participating entities. Nevertheless, mergers and acquisition are commonly challenging in terms of the integration of the companies.

 

2. Strategic alliances

Unlike M&A transactions, strategic alliances do not involve the complete exchange of ownership between the participating companies. Conversely, companies combine their assets and resources for a certain period of time to achieve predetermined goals while remaining independent.

A strategic alliance can take two different forms: equity and non-equity alliances. Equity alliances are created when independent companies become partners and establish a new entity jointly owned by the participating partners. The most common form of an equity alliance is a joint venture.

On the other hand, non-equity alliances are created through the contracts. Examples of non-equity alliances are franchising and licensing in which one company provides products, services, or intellectual property to another company in exchange for a fee.

Unlike M&A transactions, strategic alliances are much easier to execute and do not involve a strong commitment for the parties. At the same time, the benefits and growth opportunities of strategic alliances may be limited.

 

Uses of External Growth Strategies

A company can use external growth strategies to achieve a number of different objectives such as:

  • Obtain access to new markets
  • Increase market power
  • Access new technology/brand
  • Diversify a product or service
  • Increase the efficiency of business operations

Theoretically, external growth strategies may provide immediate benefits to a company as they combine the available resources of two or more entities. However, in reality, the implementation of external growth strategies can be challenging for a number of various reasons. For example, a company that wants to acquire another entity may face resistance from the target’s management or shareholders.

In addition, the selection of a potential target company (in case of a merger or acquisition) is a challenging process that involves many risks.  For example, merged companies may face a clash of corporate culture or the synergies created through the transaction may not be sufficient.

 

Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Joint Venture
  • M&A Considerations and Implications
  • Present Value of Growth Opportunities (PVGO)
  • Types of Synergies

Financial Analyst Certification

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