Maximize an M&A transaction’s value by scrutinizing operating expense

There is a lot to consider when approaching an M&A deal, regardless of whether the deal is strategic or purely financial. Often overlooked in this equation is business costs analysis for day-to-day operations, which includes utilities.

“When looking at an M&A deal, the first things we look at are utilities and the costs to operate a facility,” says Roger Zona, president and founder of TPI Efficiency. “In some instances, these can be the largest business expenses outside of payroll. Understanding operating costs and the underlying agreements can often make or break a deal.”

Smart Business spoke with Zona about negotiating operating expenses as part of an M&A event.

Why are operating expenses important to an M&A deal?

Manufacturers, for instance, have a large portion of monthly expenses tied-up in their energy costs. For some industrial businesses, the energy they use in production can represent as much as 70 percent of all expenses. That makes negotiating for the best rates critically important.

What should a buyer do once it is discovered operating expenses are out of line with current market rates?

Look at utilities, telecommunications, copiers, even cleaning supplies. Any large recurring expense should be scrutinized. If current operating expenses are poorly aligned with market cost, the M&A deal should be structured to exclude previous contracts. Ideally, the buyer will add a line item to the purchase terms giving them the option to exit any established contracts at their discretion. If that can’t be accomplished, the deal will need to be scrutinized much more intensely to compensate for the burden of poorly negotiated agreements.

Another important area to explore relates to preventive maintenance and service contracts. If these agreements are not in place or have expired, life expectancy of the equipment should be questioned. Failure to properly maintain equipment can reduce operating efficiency dramatically, reducing longevity by greater than 50 percent.

What can potential buyers learn about a company by studying its operating expenses?

Scrutinizing utility contracts and other large recurring monthly expenses can uncover patterns of behavior and how the owner approached other aspects of the business — whether they were reactive or proactive, for instance.

With long-established companies, it is not uncommon to find cooperative or noncompetitive agreements in place because of the relationships of previous ownership or management with a vendor. The new owner doesn’t have loyalty to those vendors, so there’s no need to pay more because of someone else’s previous cooperative relationship.

The discovery of poorly negotiated contracts should raise red flags, encouraging a buyer to dig deeper for other overlooked areas that could haunt their balance sheet.

Who should be involved in examining operating expenses during an M&A deal?

Utilizing consultants familiar with operating agreements along with your legal and accounting team is always advised. Experienced consultants that know what they’re looking for will bring your attention to caveats and offer great assistance during the discovery period. Additionally, a consultant can often help reduce your accounting and legal fees by pointing these teams in the right direction.

Ultimately, it is important to understand all contracts associated with an M&A deal. It can help a buyer understand how the business was run previously while giving an indication of the business’s true value. Without such scrutiny, a buyer may believe he or she is making a good deal. The reality, however, is that the buyer is underwater from the start.

Insights Energy Solutions is brought to you by TPI Efficiency Consulting