Greenfield vs. Cross-Border Acquisition: What's the Difference?

Overview of Greenfield vs. Cross-Border Acquisition

When businesses decide to expand their operations to another country, one of the major difficulties they face is whether to establish a new operation abroad through a greenfield investment or directly acquire an existing foreign company through a cross-border acquisition.

While both methods can achieve the goal of expanding a company's operations into a new foreign market, there are several reasons why a company might choose one method over the other. One of the biggest factors when expanding abroad is the regulatory and compliance rules that the company may need to research and adhere to. Acquiring an existing company can make international business expansion easier in this regard, or the parent company may want to build its own new infrastructure. Whichever method is chosen, there will be many costs and projections to consider with both types of investments.

• Greenfield investment and cross-border acquisition are two ways a company can choose to expand its business into a foreign market.
• Cross-border acquisition involves purchasing an already existing company.
• Greenfield investment involves building a brand new business from a business plan developed by the parent company.
• Different financial analysis methods are used when evaluating the profit potential of an acquisition versus a greenfield investment.

Cross-Border Acquisition

The acquisition of a foreign company can be structured in a number of different ways. A company may choose to acquire the entire company, a portion of the company, or a significant portion of the company to gain certain ownership.

Advantages

Overall, there are many reasons why a cross-border acquisition may be the optimal choice for expansion. In most cases, the foreign business is expected to be fully integrated and compliant with international laws and regulations. In this regard, it would be beneficial to retain members of the current management team and most of the current high-level operating processes for the expansion. Generally, acquiring a business abroad can simplify many of the tedious details associated with entering a new market.

Another top reason for choosing an acquisition over a greenfield investment is market share. If a potential foreign company holds a significant market share in that country, the time-to-market and competition for a greenfield investment may not be worthwhile. Other reasons why a cross-border acquisition may be better than a greenfield investment include factors such as training, supply chains, lower labor costs, lower service or production costs, an existing workforce, an existing executive management team, brand recognition, a customer base, financial relationships, and access to financing.

Ultimately, the most important factor is often cost. The acquisition team will meticulously review the costs of a cross-border acquisition versus the costs of a greenfield investment in the form of net present value, internal rate of return, discounted cash flow, and earnings per share impact. Based on these analyses, the team will want to determine the most cost-effective investment decision. As with all types of investments, there are many costs involved. Acquiring a company in another country can often be less expensive because licenses, registrations, infrastructure, and other business assets are already in place. Acquiring an existing business with existing assets is often less expensive and also takes less time to get to market.

Disadvantages

Even if an acquisition is the most cost-effective option, it's important to remember that there can be some things to watch out for. A major potential issue is that when acquiring a company, there may be regulatory hurdles that impede the acquisition due to the size of the two businesses after the acquisition or for other reasons. International regulatory approvals can be lengthy. They can also result in the acquisition being blocked altogether or requiring the divestment of certain parts that could complicate the deal.

Greenfield Investment

A greenfield investment is a corporate investment that involves constructing a new entity in another country. In a greenfield investment, the parent company seeks to create a new business, often under the parent company's brand. A greenfield investment can be made with the purpose of targeting customers in a foreign region or can involve building a facility and using labor for work that reduces the overall costs of the company. A greenfield investment is also called a foreign direct investment (FDI). In a greenfield investment, the new company is usually required to abide by all local laws regardless of its affiliation with the parent company.

Advantages

One of the top reasons for pursuing a greenfield investment is the lack of suitable foreign targets to acquire. Additionally, a company may find acquisition targets but find severe difficulties in integrating the parent company with that target. In some cases, a greenfield investment may be the best option because businesses can get benefits related to the local government by starting from scratch in a new country, as some countries offer subsidies, tax breaks, or other benefits to promote that country as a good location for foreign direct investment.

As in the analysis of an acquisition, a greenfield investment requires a detailed analysis of the investment costs and expected returns. A greenfield investment analysis typically focuses more heavily on the calculation of net present value and internal rate of return because the goal is to invest in building a new company that will generate future returns. This is different from the need to analyze an already existing business using standard analyses like discounted cash flow and enterprise value.

Disadvantages

A greenfield investment analysis can be slightly riskier than an acquisition because the costs may not be as clear. With an acquisition, analysts often have actual financial statements and costs to work with. In a greenfield investment, it can be important to use an analysis of similar companies or business models in the target market to get a framework of costs. Generally, a greenfield investment analysis involves structuring a detailed business plan along with building a financial model that includes all of the projected costs. With a greenfield investment, there can be a little more flexibility in tailoring costs to the parent company's business plan. In a greenfield investment, the parent company will need to acquire costs for land, building permits, facility construction, new facility maintenance, labor, financing approvals, and more.

Both cross-border acquisitions and greenfield investments involve understanding and complying with the local business laws of the designated foreign country.

Special Considerations: Financial Analysis

In acquisitions and other large capital project analyses, there are several common types of financial model analysis that the finance industry commonly uses.

• Net Present Value (NPV): A net present value analysis determines the present value of future cash flows for an investment. NPV is commonly used in capital project analysis where investment projections are based on hypothetical estimates. It uses an arbitrary discount rate depending on the risk, with the U.S. Treasury rate as the risk-free rate.
• Discounted Cash Flow (DCF): A discounted cash flow is similar to NPV. DCF discounts a business's future cash flows to arrive at the present value of the company. DCF is more commonly used when valuing already existing companies. It uses the company's weighted average cost of capital (WACC) as the discount rate.
• Internal Rate of Return (IRR): The internal rate of return is the discount rate in an NPV calculation that results in a zero NPV. This rate provides analysts with the rate of return on the investment.

Conclusion

Both strategies, greenfield investment and cross-border acquisition, are effective ways for companies to expand into foreign markets. While they share similarities, such as the need to research local laws and regulations, the key difference lies in the approach. Cross-border acquisition involves purchasing an existing company, which offers the advantage of an established market presence and existing relationships. In contrast, greenfield investment is about building a new business from the ground up, allowing for complete control over processes and branding, but it can be more costly and time-consuming to get to market. Ultimately, the decision between the two must be based on a careful analysis of the company's objectives, costs, risks, and the market conditions of the target country. Detailed financial analysis, including NPV, IRR, and DCF, is crucial for making the most suitable investment choice.