External growth (also known as inorganic growth) refers to growth of a company that results from using external resources and capabilities rather than from internal business activities. External growth is an alternative to internal (organic) growth. However, internal and external growth should not be considered opposites.
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 pursue external growth using two primary vehicles: mergers and acquisitions (M&A) and strategic alliances. The main difference between the two is in regard to change of ownership. M&A deals involve an exchange of ownership between the companies in the transaction. Conversely, a strategic alliance enables 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 a 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 may become 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, M&A transactions can provide substantial benefits and growth opportunities to the participating entities. Nevertheless, mergers and acquisitions are commonly challenging in terms of the integration of the companies.
2. Strategic alliances
Unlike M&A transactions, strategic alliances do not involve a complete exchange of ownership between the participating companies. Instead, companies combine their assets and resources for a certain period of time to achieve predetermined goals while remaining independent.
A strategic alliance can take one of two 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 contracts. Examples of non-equity alliances are franchising and licensing agreements, 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 require an extreme commitment from the involved parties. However, the benefits and growth opportunities of strategic alliances may be limited, as compared to the opportunities that an acquisition may offer.
Uses of External Growth Strategies
A company can use external growth strategies to achieve a number of different objectives, such as the following:
Obtain access to new markets
Increase market power
Access new technology/brand
Diversify a product or service
Increase the efficiency of business operations
The implementation of external growth strategies can be challenging for a number of 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 in and of itself, and one 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 to produce the gains that were anticipated to result from the merger.
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 CFI resources will be helpful: