Mergers and acquisitions, or M&A,
can be very complex processes that
may be as risky as they are rewarding. Differences in internal controls, management styles, processes, data volumes
and complexity of integrating systems
between two organizations looking to a
merger or an acquisition can often result in
the increase in business risks exponentially. Organizations that are unable to reach a
consensus in these aspects of management
often fail to achieve the proposed result of
combining their business operations
together.
Despite these risks, many organizations
use mergers and acquisitions as a fast track
tool for rapid expansion and growth. In a
large number of mergers and acquisitions,
a buyer overpays for purchase of a business entity and the merger fails to meet
expectations.
Smart Business spoke to Richard
Millman, CPA/ABV, CVA, the principal-in-charge of the Forensic Accounting
Services Team at Tauber & Balser, P.C., for
a look at the risks involved and the common mistakes that happen in mergers and
acquisitions.
How can a prospective buyer’s assumptions
create differences between expected and
actual results?
Financial and business assumptions
form the basis of a model underlying a valuation process and the purchase price estimated for buying an entity. Cases where
buyers forecast unrealistic synergies and
economies of scale often result in high-risk and low-return M&A transactions.
One common assumption that leads to
wrong and mistaken judgment is that the
buyer would run the business more effectively and efficiently than the old owner.
Another common mistake in M&A transactions is the buyer’s assumption of using
unrealistic and unsupported industry
standards for benchmarks. The result of
this could be the buyer using a rate of
return less than the cost of his capital
or purchase cost. This, on paper, yields
good returns but, in reality, would be
devastating.
What should a potential buyer do to determine whether a company is worth the asking
price?
There are three approaches to valuation
known as the cost, market and income
approaches. Often, companies follow a
rule of thumb rather than a complete analysis for decision-making. In such cases,
important considerations, including those
impacting nonoperating assets, changes in
market dynamics, etc., are ignored.
Before making a formal offer to merge
with or acquire another business, management must ensure that a complete analysis
using all three approaches should be performed to make the best decision and determine a reasonable offer/purchase price.
Are there special concerns when valuing a
company in an industry experiencing a lot of
consolidation?
Inflated pricing multiples are often a
major problem in the valuation exercise.
Industrywide consolidation often leads to
this issue, and, in certain cases, the result
becomes unrealistic. Instances where companies have paid unrealistic premiums to
maintain market shares are plentiful.
Is due diligence really that big of a deal?
What is the worst that can happen?
Due diligence is the systematic process
of understanding and evaluating a business
proposition. This ideally would cover both
strategic and operational areas, including
financial and technical aspects and
resource-related issues. In many M&A
opportunities, incompetent due diligence
has lead to overlooking risks, including
financial-related risks like unpaid taxes,
fines, obsolete assets and organization
risks such as employee retention issues,
poor management control, etc. The result
can be devastating to running the business,
even resulting in bankruptcy.
Issues that come up in the due diligence
process must be carefully understood and
examined, and solutions should be identified. The impact of due diligence may
include:
- The potential buyer withdrawing from
the deal if information from due diligence
makes the investment highly risky; - Revision of the valuation of investment
and adjustment of the potential price that
may be offered to the seller; and/or - Resolution of the problem and revaluation of the investment proposition.
The best way to ensure M&A activities
succeed is through due diligence. Valuation
analysts play a vital role in helping an
organization evaluate mergers and acquisitions transactions. Thus, in reality, it is best
suited for an organization to leave the valuation process to the experts than perform
it itself.
RICHARD MILLMAN, CPA/ABV, CVA, is the principal-in-charge of the Forensic Accounting Services Team at Tauber & Balser, P.C.
During his 40 years of experience, his professional background has spanned both the public and private sectors. He has provided litigation support and expert witness services in cases involving accounting principles, applications of Generally Accepted Accounting
Standards and accountant malpractice. He has also consulted in the area of mergers and acquisitions throughout his career. Reach him
at [email protected] or (404) 814-4905.
