Due Diligence – ‘Falling In Love & Other Pitfalls’ – Part II

 

For many people, the work of acquiring companies is an exciting and invigorating process.  It can improve morale and provide new motivation for the Controller/CFO and finance team.  This is where we get to put our accounting skills to work.  We’re glad to see our business growing (and usually  glad that we are the acquirer not the acquired company).

Making an acquisition is not something that happens in a vacuum or a sterile environment.  If you are working closely with the target company, you get to know the people.  Sometimes you can even bond with them.  You may fall in love with the idea of new challenges, new people, new projects.  When this happens, we have a tendency to filter out those little warning signs and even some big warning signs.  When this happens we have moved into a situation where we are no longer independent.  This poses serious risks for you and your company.  There is not a simple solution to this problem.  I have been a victim of the ‘falling in love’ syndrome and experienced deep disappointment when an acquisition failed to go through.  I think the more experienced we are, the better able we are to remove the emotion from the equation.  What are some ways to avoid this? (Back to my checklists):

  • Start two checklists:  One is for pros and one for cons.  Be honest and list every good reason why this purchase should not be made (even if you are the only one that will see this list)
  • Referring back to Part I and understanding why the business is for sale………..the reasons may belong on your ‘cons’ checklist.
  • Try to think of yourself as the consultant on the acquisition project.  If you were brought in from the outside to assist in evaluating and valuing the business, it would be assumed that your findings would be based on the fact pattern alone.
  • Remember – everyone at the target company will be on their best behavior and any eyesores or outward manifestations of a problem could well be hidden from you.
  • Generally,  a company attorney is involved.  Attorneys are very risk averse and often get a lot of push back as they write or review  Purchase Agreements.  Make sure you understand the risks from the attorney’s point of view.
  • There are different ways of structuring a purchase, primarily stock or asset purchase.  Your attorney should be your guide.
  • Most acquisitions transpire under the veil of confidentiality.  It is difficult then to find out what suppliers of the target think about the company, or anyone else for that matter.   A supplier can often provide some great information on their customers.

I urge you to remember that in most cases, if the current acquisition doesn’t work out, take your buying power elsewhere and find a better investment for your company.  It is a lot easier to buy a company then it is to shut it down after a couple of years as an under performing asset.

DUE DILIGENCE…….do you have a checklist? – Part I

 

I want to talk about the minefield I call ‘Due Diligence’.  I also want each of you to understand that your particular industries may be very different and thus require different kinds and levels of due diligence.  Therefore, you need to consult with your outside accounting firms and/or attorney(s)  for further discussion.

I am fortunate to have been involved in a number of acquisitions over the years, some big and some not so big.  It’s a great area of accounting and financial work which allows you to understand how businesses operate from the ground level.  However, this is an area that requires collaboration between people who are knowledgeable in such matters, such as your company attorney and outside accounting firm.

If you happen to be working for a publicly held company, most of those companies have well developed processes and procedures to guide them through the process.  But what are some of the things  (and certainly not all) you should be worry about.  Many small to medium enterprises (SME’s) achieve growth through acquiring other businesses………..sometimes in the same industry and sometimes not.  If you are a controller involved in or leading the acquisition team, be careful.  If the acquisition goes great and prospers, those who brought it to the table will generally get the credit, not you.  That’s fine.   If it fails during the process or turns out to be a dud after acquisition, you will likely be tainted by it or directly blamed.  If you have ever participated in the acquisition process, you should have built a checklist the first time and then refined and modified it as acquisitions were made.  But if you have no experience, you need to study how this process works and begin to build your checklist.  .  There are some great examples out there on the Internet, and on websites like AICPA.org if you are a member. I also recommend you visit the website of John Wiley & Co for books and manuals that might be of assistance.  Pitfalls abound in the acquisition business.  Trust me.

Critical to the process of buying a company is understanding that there can be limiting factors to its’ success.  First, understand why the company is for sale.  Reasons may include:

  • Owner wants to cash out and retire
  • Owner lacks capital to remain in business
  • Owner is afraid of continued credit risk
  • Owner does not feel capable of managing his company’s continued growth (result of rapid growth)
  • Owner is seeing a decline in his business
  • Owner is struggling with compliance issues (this can be an expensive area depending on your industry)

There are numerous reasons but I think the above covers a lot of them.  Whatever the reason, you need to apply the same due diligence learning why it is  for sale that you would if you were buying a previously owned home for your family.  Wouldn’t you ask the homeowner  ‘why are you moving?’, ‘how are the schools in this district?’, ‘what about the crime rate?’, etc.  You need an honest answer about why the business is for sale just as much as why that home is for sale.

Another area requiring skepticism, from my own past experience, is the appraisal that you are presented with.  Many businessmen, realizing the time has come to sell, will pay for an appraisal.  However,  the true value of a business is what someone is willing to pay in an arm’s length transaction.  I have seen a number of big appraisal books, plenty of drawings and photos, etc.  They can be works of art, and they are not cheap.  Do not accept an appraisal as the gospel.  Unfortunately there are not a lot of comparatives out there.  In the home buying business yes, not in the business buying business.  That’s a serious challenge.

Next week we will talk more about the acquisition process.  By the way, that includes a discussion of ‘falling in love’!

In the meantime if you have any questions, submit them below.

 

 

 

 

 

 

 

 

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