Buying a business?

Business owners decide to pursue acquisitions for a variety of reasons. A longstanding company with a mature product line may want to jump-start its performance. The owner has three options: invest in
internal product development, partner with
alternative suppliers or acquire a business
with a suite of complementary products.

A company with a strong local presence
may be interested in expanding geographically. The owner can either try to build a presence from the ground up or acquire an existing business in the target location.

Or perhaps a company believes there is an
opportunity to sell its existing products or
services to a new industry. The owner can
expand his or her existing business development function or purchase a business with a
foothold in the target industry.

These scenarios underscore the importance of understanding strategic objectives
before embarking on an acquisition

“You must know what your endgame is
before you can determine whether acquisitions will help you reach your goals,” says
Chris Meshginpoosh, Director, Kreischer
Miller, Horsham, Pa.

Here, Meshginpoosh discusses with Smart
Business
the key considerations when buying a business, including due diligence procedures and red flags.

After an owner determines that an acquisition is the best way to reach strategic goals,
what’s the next step?

Targeting businesses for acquisition can be
a full-time job, and a lot of companies don’t
have a corporate development function in-house. If an aggressive acquisitions strategy
is critical to achieving your company’s objectives — say you want to be in five new countries in the next five years — you will want to
devote resources to the targeting process. In
these circumstances, owners can bring in a
team or outsource to an organization with
the resources to identify potential targets.

What counsel should owners seek when performing due diligence on target companies?

There are two sides to every due diligence
assignment. First is financial due diligence, which includes evaluating financial performance, business trends and other financial representations made by the seller. Here, either
your accountants or accountants with experience in the target industry are great
resources because they know the value drivers in your business.

Second is legal due diligence, the importance of which can’t be understated.
Accordingly, it’s critically important to make
sure that you engage legal counsel with
extensive merger and acquisition experience.

What red flags signal that a target company
isn’t a fit?

This depends on the objectives of the buyer
and the nature of the industry. But I think it’s
always a good idea to find out the sellers’
expectations about continued involvement
in the business. Do they plan to retain any
ownership? Will they exit the business
entirely?

If you don’t have management capacity to
immediately take the reins and execute the
integration plan, be wary of a seller who does
not offer to provide active, transitional management or consulting for a period of time. A
seller that retains some ownership — or better yet, leaves some of the purchase price at risk — is probably more comfortable with
the company’s ability to achieve its goals.

What financial warning signs should owners
scrutinize?

Look for one-time or nonrecurring transactions that have driven recent earnings. Steady
growth is easy to analyze, but be suspicious
of anomalies. Has a stable business shown a
recent surge in financial results? The spike in
results may be due to a one-time sale to a customer or a change in the way the company is
selling its product or recognizing revenue, or
it may infer that the company has simply
depleted its sales pipeline.

What earnings line items should the seller be
asked to explain?

If a seller says there are ‘add-backs,’ find out
whether those are truly costs that will not
occur after the sale of the business. For
instance, in valuing a business, it might be
reasonable to add-back payroll expenses for
the relatives of the owner who are not active
in the business. However, if the payroll costs
relate to a relative who performs services
critical to the business, adding back the costs
is probably inappropriate.

When should an owner walk away from a
target?

It’s always a good idea to set a maximum
price before negotiations begin. Far too
often, buyers get caught up in the momentum
of the transaction and gradual accommodations on deal terms end up eroding post-deal
returns. If you set a price limit and you can’t
reach an agreement without exceeding your
maximum, then sometimes the best answer
is to walk away. In addition to price, it’s
always critical to objectively evaluate the
feedback of financial and legal due diligence
advisers to ensure that you don’t jeopardize
the strength of your existing business by purchasing the wrong business — or the right
business on the wrong terms.

CHRIS MESHGINPOOSH is a Director in the Audit and
Accounting Group at Kreischer Miller, Horsham, Pa. Contact him
at (215) 441-4600 or [email protected].