Growing your company through mergers or acquisitions can provide a tremendous boost to business, but isn’t something to take lightly.
“You have to consider how you want the organization to grow,” says Kenneth M. Haffey, CPA, CVA, a partner with Skoda Minotti. “When you start identifying targets, consider what sort of operational challenges you will face. We call that smart growth — what should an organization look like for the short-term and the long-term.”
Smart Business spoke with Haffey about what owners should know before making the deal.
Before considering growing the business through a merger or acquisition, what should a business owner think about?
At the end of the day, you have to know what your goals for the merger or acquisition are. Will the target company be an add-on or tuck-in to an existing segment of your business? The bottom line is to understand the who, what, when, where and why of the potential acquisition or merger before you start the process.
Although often overlooked, the ‘where’ is actually just as important as the other questions. Acquiring or merging with companies in different parts of the country poses specific operational challenges, not the least of which is banking. With whom should the company bank? There are many large national banks now, but that wasn’t the case 10 years ago. If one of the involved company’s banks does not have a presence in the other company’s geographic area, then simple operational issues can become a challenge.
What should business owners keep in mind during a merger or acquisition?
Pricing is one element. Another is structuring the transaction correctly, which comes with hiring competent advisers. I can’t tell you how many times someone has their niece or nephew who just graduated from law school and took one M&A class working on these major transactions. Needless to say, that poses several challenges. You need a deal expert to make sure little things aren’t made into big things.
Years ago, when we were working on a deal with a client, three times in the first hour of our conversations, the attorney on the other side of the table came up with a ‘deal breaker.’ The third time I said, ‘If we are one hour into this and you already have three deal breakers, maybe this isn’t such a good idea.’ But this person was just trying to show his client that he was ‘in charge’ and that they would get the better of us.
After that, the individual owning the other business grabbed his attorney and said, ‘Let’s go out in the hall and talk.’ When they came back in, they had a completely different attitude. It wasn’t us versus them; it was us and them. Acquisitions and mergers only work if it is fair on both sides.
A confident and competent deal attorney and accountant or financial adviser will help make that happen. It’s important to make sure you understand the other side’s points. If every negotiating point is only going one way, why waste the other side’s time?
How should business owners prepare for an acquisition?
Have a plan in place. Set a time horizon, because, most of the time, things take longer than you think. It takes a while for both sides to perform financial and legal due diligence, and to figure out the operations. It’s not unusual that it would take four to six months from the time the letter of intent goes out until the deal is consummated. It’s more than a couple of meetings, but it also shouldn’t drag on too long or the individuals operating each entity may have their eyes off the ball of their own entities. You still need to run your own business.
What sort of tax ramifications should business owners prepare for with mergers or acquisitions?
Proper tax planning is important to make sure your corporate structure fits on an overall basis. Proper planning must be done with regard to the type of entity. Are you buying it as a subsidiary, a separate division or setting up a new company to do all this? For example, if a C corp. is buying an LLC, you have to prepare for the specific challenges for that situation.
Make sure you do your tax-related due diligence to ensure that all sales, property and payroll taxes have been paid, because the acquirer becomes liable for those taxes if they haven’t been paid, irrespective of the fact that it should have been paid by the seller. You could be on the hook for a lot of unpaid tax.
We just helped a client buy a company, and we found the company owed $300,000 in unpaid state and local taxes. That discovery drove a substantial purchase price adjustment.
Generally, when there is a problem, it is not so much federal income taxes; more often than not it is state and local taxes. Sales taxes, property taxes, payroll taxes — things like that.
How else can business owners determine what to pay when purchasing another company?
It’s important to understand the sustainability of the target company’s earnings. How does its revenue come together; what kind of clients do they have? For each client, determine if it is a special project client or if it is a client that has been around for a long time. Also, determine which clients will be continuing on with the company. That, as much as anything, drives purchase price.
Also, you must be aware of what kind of liabilities you will be assuming. Are there leases or mortgages? That is where financial diligence will uncover the liability side, and find out what is still owed to make sure there are no surprises. You don’t want to find out after an acquisition that you don’t really own your new assets — that you are leasing equipment.
Kenneth M. Haffey, CPA, CVA, is a partner with Skoda Minotti. Reach him at (440) 449-6800 or firstname.lastname@example.org.