When acquiring a company, it’s important that there are no surprises after an agreement has been signed. That’s why it’s critical to do your due diligence to ensure that there are no unknown problems that might arise after the closing.
“Companies that conduct a volume of transactional work — a lot of acquiring of businesses — understand the importance of getting information on the target company and assembling the proper team to review it,” says Patricia A. Gajda, partner and chair of the Corporate Group at Brouse McDowell.
Smart Business spoke with Gajda and Rachael Mauk, an associate at Brouse McDowell, about what areas to look at and the potential pitfalls in the due diligence phase of an M&A transaction.
What is involved in the due diligence process?
From a business, legal and financial perspective, you look at everything in the company that could have a risk or liability associated with it.
Usually the buyer will provide a list of documents for the seller to gather, including:
• Organizational documents.
• Financial documents, including three or four years of audited and unaudited financial statements, monthly statements, any audit reports, receivables, etc.
• Contracts with vendors, customers, etc.
• Real property information such as title documents, deeds, title insurance, zoning variances and leases.
• Permits and certifications.
• Environmental testing reports, remediation records, audit information.
• Intellectual property (IP) including patents, copyrights, trademarks, trade secrets, confidentially agreements, and licenses and software agreements.
• Employee information.
You also want to investigate the company to examine past and pending lawsuits, insurance claims, product liability questions, warranty information — how often there were product warranty claims — and delve into the history.
Due diligence can play an important role in determining the final transaction price. For example, if you find out the target company you intend to buy has a $5 million lawsuit pending against it, you will want to determine if and how that will negatively affect the company, even if you’re not going to take the liability for the lawsuit.
Are there things you find that might cause you to back out of a deal?
It will depend largely on your motivation for acquiring the target company. You may be buying a company because they have the latest product, which you want to incorporate into your product line, only to discover that the target company doesn’t own the IP or the IP associated with the product was not protected. Alternatively, you might uncover product warranty issues that bring into question whether the product works, or review the financial records and find out it’s not a profitable line of business.
It’s not just attorneys who do the due diligence. A company will put a team together to look at the various segments of the business. Accountants will look at the financial statements and tax returns. If there are environmental issues, you might have an environmental consultant do additional testing.
What pitfalls do companies experience in doing due diligence?
They do not allow for adequate time for due diligence. A strategic buyer is generally familiar with the business, so it may think it already knows everything. Things can fall through the cracks, so leave enough time for adequate review, testing and follow up. The process can take from a few weeks to 30 days or more if it’s a complicated business.
Typically, due diligence is done simultaneously with negotiating the purchase agreement. It might result in a purchase price reduction because something discovered doesn’t add up to the price that was originally discussed. You might find there’s the potential for environmental liability and seek an indemnification for that specific item — due diligence can lead to specific requests in the purchase agreement.
Once you’ve completed the due diligence, you’re close to signing the transaction agreement and the purchase can go as planned.
Patricia A. Gajda is a partner and chair of the Corporate Group at Brouse McDowell. Reach her at (216) 830-6830 or email@example.com. Rachael E. Mauk is an associate at Brouse McDowell. Reach her at (216) 830-6846 or firstname.lastname@example.org.
Insights Legal Affairs is brought to you by Brouse McDowell
Recovery continues to be slower than most businesses would prefer. Part of the slow growth is due to concern from many business owners regarding whether they can trust some of the leading economic indicators released in the past few months.
On a positive note, recent trends have shown that unemployment is being reduced overall. The National Association of Manufacturers also reported that more than 31,000 new U.S. manufacturing jobs were created in February. This increase, however, is tempered with the belief that many unemployed individuals have simply given up on job searches, as they have now been out of work for an extended period. The end of their search effort causes many to fall off of the tracked statistics. This may be causing some lower-than-actual unemployment numbers to be reported. In addition, a recent University of Michigan study showed consumer confidence figures have fallen slightly due to weakening perceptions about the economic environment.
Two other areas facing business owners have caused them to move at a slower pace when considering expansion, acquisitions and hiring of additional employees. These two areas are taxes and the looming health care changes. With the potential for higher taxes and higher health care costs on the horizon, many entrepreneurs are taking a wait-and-see approach. Thus, the reports of companies continuing to pay down third-party debt and stockpile cash still exist.
It seems businesses have returned to profitability as a result of their concentrated efforts implemented to endure the economic downturn. The threat of losses, liquidity issues and, in some cases, covenant violations forced many businesses to lean up operations, challenge spending and do more with less. As a result, many are producing more with fewer resources and have improved their processes. Earnings levels have improved, but most results are still below the levels experienced in the mid-2000s.
Also of concern is uncertainty in foreign markets. While we have had a credit and debt crisis here, overseas trouble has many business owners contemplating international business relationships and opportunities. In the mid-2000s, many production jobs were moved overseas to benefit from inexpensive labor. With the current domestic economic conditions and the lack of stability driven by the uncertainties in the Eurozone, there are rumblings that U.S. companies may work to grow domestic manufacturing and pull jobs back to the U.S. Innovations also are occurring in certain niche areas, and the shrinking cost advantage of outsourcing production is becoming more evident. Job growth continues to be a major focus domestically, and labor negotiations of major industries, such as auto makers, have demonstrated the desire for large companies to guarantee sustainability and promise to keep jobs in the U.S.
There is also concern regarding the stability of the buying power of foreign markets. U.S. companies have continued to expand their penetration into foreign developing markets. The ultimate results of the various national debt issues in the Eurozone could create an economic ripple effect that could affect demand for U.S. products in many foreign markets. Also, the continued political changes and instability in eastern countries can create swings in energy prices and product demand in those markets. This creates difficulty in planning for growth and expansion — and correspondingly a fair amount of caution when it comes to the timing of capital investment and business expansion.
Merger & Acquisition Activity
While the aforementioned factors have slowed down private business owner activity related to expansion and acquisitions, another business segment seems to have picked up. Private equity groups and private investors have been much more active in recent months. There has been significant public discussion in the past 18 months regarding cash that is on the “sidelines” waiting to be invested. We have seen that as the economy begins to expand and smooth out, more M&A deals are being contemplated. Also, business valuations are returning to more normal and expected levels driven by those wishing to market their businesses, and banks are becoming more willing and involved in financing such deals. We view this as an encouraging sign and an indication of continued movement in the right direction.
Each business faces unique challenges, but all ultimately need to consider, plan for and execute a succession plan. Whether the plan involves selling the company to an unrelated third party, transitioning or selling the company to the next generation, an ESOP or some combination of these, this issue has to be addressed. The recent increase in merger and acquisition activity has been driven in a number of cases by exit strategies employed by many business owners. As the baby boomers continue to exit the workforce and leave their businesses, we will see more and more movement and opportunity in this M&A wave. When these decisions are made and the process starts, planning can have a significant effect on the company’s valuation and the ultimate profit realized by the owner. This truly is one of those areas where “an ounce of prevention (of negative results) is worth a pound of cure.”
Here are a few planning ideas that can be game changers when an owner is looking to improve value:
- Perform due diligence on your business and your business processes and activities. Many sellers believe the diligence process is the buyer’s responsibility. While buyers will spend a great deal of time and effort on due diligence, performing self due diligence can overcome a number of surprises, allow the seller time to position its operations and activities to provide the greatest advantage and better prepare the seller for questions asked during the process. Being prepared when soliciting bidders also will likely increase the number of bidders you may be able to attract.During this process, you should consider reverse due diligence, or preparing the data that will likely be requested during the due diligence process. These are standard documents requested in most diligence engagements. Having this information ready on the front end adds value and helps move the process along. Delays in outside or third-party diligence have been proven to affect deal values.Also, have your company’s financial statements audited by a firm that potential buyers consider reputable. Audited financial statements provide immediate credibility.
- Make sure you impress upon buyers the value of the company you are offering to them. Build a business case for why the company will continue to prosper and grow and what positive effects the existing infrastructure will have on such growth.
- Document agreements with employees and third parties. It is important for buyers to mitigate the unknowns when buying a business, so the more documentation for contractual arrangements, the better.
- Be proactive relative to unresolved or potential litigation. Review pending or threatened claims with your attorneys and be honest about what situations exist. Resolve issues as diligently as possible. Make sure to include all potential human resources issues that may exist.
- Avoid accounting discrepancies, unusual transactions and changes in reporting methods. An audit, as discussed above, can assist with this. However, remember that any such instances will need to be explained and will be challenged by a buyer. Clouding facts will lead to more questions and may ultimately impact the value of your deal.
When it comes to the value of your company, you can never be too diligent. For more ideas on how to enhance value, contact a BKD advisor.
Scott L. Fields is a partner at the Houston office of BKD, LLP. Reach him at email@example.com.
Article reprinted with permission from BKD, LLP, www.bkd.com. All rights reserved.
When Punit Shah saw that people were no longer paying premiums for completed real estate development projects in 2008, he knew that his company needed to get out of the construction business.
“We saw where the market was going and we had to take reactive measures to make sure that our future was protected and the future of our employees was protected,” says Shah, the president and COO of Liberty Group of Cos., a Clearwater, Fla.-based real estate company with 400 employees.
To keep the company profitable, Shah has implemented a new business strategy to grow through aggressive acquisition of existing properties.
Smart Business spoke with Shah about the keys in investing in growth through acquisitions.
What is your approach to new acquisitions?
Any acquisition that we’re buying has to have a value-add component to it and have a big upside that we can conservatively rely on to have a long-term gain in.
One thing that really makes us different is our ability to analytically look at every piece of information upfront. That makes it a lot easier for us on the back end, because we know what we’re getting into and we know how to proactively deal with whatever is coming our way.
So it’s something that we think may tie up equity or capital for a really long time and then have minimal returns, we usually pass on that deal, because we want to make the most and highest return that we can on our equity. We also want to make sure that it’s a safe investment, because right now is not the time to be making risky investments. Now is the time to be making investments that you are 100 percent confident in and that you’ve got a reasonable return on the money that you are putting at risk.
We’re not forecasting tremendous numbers with a forward-looking basis. We’re buying what we deem to be profitable as-is right now. As the market improves overall, as the economy improves, as our management team goes in there and adds more professionalism in overall management of the asset, we see that all as value-add opportunity.
What criteria do you use to evaluate investments during due diligence?
The most primary thing is location and demand generators. We want to be conservative and consider all different options, whether if there is a terrorist attack, what that would do to the core business of the hotel, during recessions, what happens during peak periods. So we look for diverse demand generators. We look for location of course. Then we look at the physical plans of the hotel or whatever the asset is. We look at the long-term intrinsic value of the asset itself but also the submarket and the overall region. We want to know if this is something that is going to be sustainable and is there going to be a demand generator for this property 10 years from now. As far as my ranking, it would go in that order.
We’re looking just for the best products that we can find, and we’re filtering out anything that doesn’t meet our core criteria. We’ve been very diligent about establishing that criteria upfront and knowing what we’re pursuing.
What mistakes can you make when pursuing acquisition opportunities?
The biggest thing anyone can do if they’re getting involved in what we’re doing is make sure they spend the time, money and resources on the due diligence. It’s almost turning into the height of the market again on a different scale, because people are just buying things sight unseen, guns blazing and not necessarily knowing what the repercussions are because there are a lot of legal complexities when dealing with distressed assets. I’ve seen a lot of people who are just jumping in all at once without understanding the risks involved with those investments. The other thing is real estate and cash-flowing businesses are still businesses and you have to have great management and employees to make those investments profitable. You can’t just buy an assisted living facility or hotel and expect just because you got a good deal on it, it’s going to turn profitable. It’s not like land. There is an inherent business component to it, and a lot of people fail to realize that when they are looking at these types of deals.
How to reach: Liberty Group of Cos., (727) 866-7999 or www.libertyg.com
There are two words to apply to commercial real estate purchase contracts: Buyer beware. With sophisticated sellers and sellers’ agents working to leverage the best deal for the property, buyers must approach commercial real estate purchases with eyes wide open.
Due diligence is a period of time starting after a proper purchase agreement is executed and continues until the escrow opening. It is the prospective buyers’ window of opportunity to uncover what they actually are buying, to climb out of that window to renegotiate or walk away from the deal.
“Purchasing commercial property is not always, ‘What you see is what you get,’” says Terry Coyne, executive vice president, Grubb & Ellis. “The whole point of due diligence is time to uncover the unknown.”
Smart Business spoke with Coyne about maximizing due diligence to help ensure costly problems don’t arise after finalizing a commercial real estate purchase.
What elements of a commercial building purchase are part of due diligence?
There are three separate columns of due diligence, including physical, financial and title. Physical due diligence is the obvious inspection of all physical components of the building, including any components that are in the earth or built on the site. This includes the roof, the structure and anything that relates to environmental issues, such as Phase 1 environmental reports.
The big items here are environmental concerns and the roof. If you don’t do an inspection on the roof, it might cost you $4 a foot, which on a large building could be an enormous amount of money.
Financial due diligence involves getting a loan and primarily includes the appraisal and the credit quality of the buyer. The credit quality of the buyer is extremely important, so make sure the appraiser you select is informed and has the required knowledge about the specific asset class so the appraised understands what the values are. You don’t want a residential appraiser doing a commercial appraisal, or an industrial appraiser assessing an office building.
Due diligence on the title includes a survey that will show the physical location of the property and any encroachments and easements, and a title report which would show you all the issues on the title relating to the quality of the deed.
How has due diligence for property buyers changed in the last decade?
The appraisal process and aspects of environmental due diligence are stricter today because of the Dodd-Frank Act. The changes mean you can’t talk to your appraiser and the bank can’t talk to your appraiser – the appraiser has to be independent. You run the risk that your appraiser may not be fully informed as he or she could be, because of a lack of interaction with the bank or the buyer. In the past, buyers could communicate openly with their appraiser to share information, ensuring they were fully informed.
Environmental aspects of due diligence are constantly in flux. Asbestos and PCBs were a critical topic years ago, but now they are more understood and expenses to deal with them are much more controllable.
The big question today is black mold. The presence of black mold is not the end of the world, but it’s something to be aware of, since there is a cost for remediation if it’s discovered in your building.
What are the most important aspects of due diligence?
Former Secretary of Defense Donald Rumsfeld coined a term applicable when you are told buyer beware: ‘the unknown unknowns.’ The unknown unknowns of due diligence are things you can’t see, including title concerns and environmental issues. It’s the things you can’t see below ground or on a sheet of paper.
As far as the title is concerned, easements are the biggest worry because they have an impact on the property value. If you don’t perform a survey, you may later discover an easement that runs right across your parking lot or alongside your building. All of a sudden you find out you can’t use these areas the way you had planned because your next-door neighbor has an easement to drive over your property or use your land for oil and gas drilling.
On the environmental side, you don’t want to discover after the sale the presence of an underground oil storage tank, or that you’re downstream from a paper mill that used to dump chemicals in the water, and now they are leaching onto your property.
What happens if due diligence reveals problems?
You have three choices. The first is to get an extension of time to understand it better. Second, you can get a reduction in price. The third choice is to walk away.
It all depends where you are in the process. If it’s bad, you walk away, but it’s not often that deals die.
If it’s manageable, you get more time. If you’re interested and it’s just a question of money, then you ask for a price reduction.
How can buyers best protect themselves when acquiring commercial property?
Talk to your broker or your attorney before starting the process so you can make a fully informed decision. You can obtain a lot of free information from people in the business to help you understand the risks. Commercial contracts are sold as-is – buyer beware.
There are sophisticated parties on both sides of these transactions — you want to make sure you have protection. It’s hard to go back and sue someone on a commercial transaction when things were fully disclosed.
Terry Coyne is executive vice president, Grubb & Ellis. Reach him at (216) 453-3001 or Terry.Coyne@Grubb-Ellis.com.
Insights Real Estate is brought to you by Grubb & Ellis
When you’re considering buying a company, it’s not just a matter of locating a target and writing a check. There’s a lot that goes into doing proper due diligence, and if you fail to do it right, the transaction could be disastrous, says Thomas Vaughn, member, Dykema Gossett PLLC.
“From the purchaser’s perspective, conducting an effective due diligence process is critical to maximizing value from your acquisitions,” says Vaughn.
Smart Business spoke with Vaughn about why due diligence is critical to ensure a successful acquisition.
When considering purchasing a business, what is the first step?
Start by assembling a team of in-house and outside lawyers, inside and outside financial professionals, and possibly experts in various areas impacting the target. In the due diligence process, it is the job of the buyer to learn and understand everything it possibly can about the prospective target, and that requires a very deep dive by the due diligence team.
What is the next step?
The team should develop a due diligence strategy, and one of the most important components of that is to agree on the purpose of the due diligence effort.
From a buyer’s perspective, due diligence can be a very expensive process, so it is typically done in stages to keep costs down until the buyer is certain it is going to complete the transaction. As a result, in the preliminary due diligence, you are trying to determine the target company meets your investment parameters. You’re looking for ‘go, no go factors.’
The early stages of due diligence are very financial and operations oriented. For instance, making sure the financial statements and projections accurately represent the company’s business prospects and that there aren’t any major customer problems or potential defections are critical elements of due diligence.
From a legal standpoint, you look for high-dollar legal issues, like pending litigation or claims, or legal impediments to completing a deal, such as regulatory issues.
Also determine that the value you see in the company is an accurate perception of its true value. As part of that, identify and confirm synergies. All of these efforts will help you negotiate the purchase price and other deal terms.
Once you are satisfied with value and have signed a letter of intent, you can conduct the detailed part of the due diligence process.
How do you proceed with the detailed due diligence?
This is when the process starts in earnest. Have your team divide up responsibilities so that you’re not duplicating efforts and you are conducting the process as efficiently as possible. You want to make the process as smooth as possible for the seller. Due diligence is burdensome and time consuming for the seller. Don’t have multiple people asking the same questions or asking for the same documents.
One of the best ways to help this run smoothly is to present the seller with a detailed checklist. Often there is information listed on there that the company doesn’t have, but you can use the list to trigger the seller to think through the information documents the seller has and should be providing to you. Then keep the list updated to reflect documents received and make the list available to all team members
How is the due diligence information delivered?
Determine up front the deliverable to come out of the due diligence process. Is the expectation a written report from the accounting and legal staff? That is the most typical result, but there is an expense involved, so you have to determine if you want to incur that. You can also start with an oral report or short written report that notes red flags and items that are potentially problematic as a precursor to the full report.
That report should come with recommendations as to which problems can be potentially fixed and how to fix them, or whether the problem is so significant that it should have an impact on the purchase price or the decision to move ahead. Another outcome when due diligence identifies problems or uncertainties might be to have part of the purchase price paid as an earn-out. If certain things represented by the seller happen, you’ll pay the full price, but if they don’t, you won’t have to.
What are some red flags?
The biggest one is a very disorganized seller. In this case, the buyer needs to do very thorough due diligence. Lack of documents where you expect to see them, or poorly drafted documents or contracts, are also an issue.
Another red flag is a seller who provides you with certain due diligence but is slow providing other information. This may be an indication the seller is holding back bad news.
How does due diligence help in preparing schedules used in the typical acquisition agreement
The seller makes representations and warranties in the acquisition agreement and puts exceptions in the schedules. Then the buyer reviews them to get comfortable that nothing new has appeared in the schedules that was not disclosed in the due diligence process. It’s not unusual for new information to appear in the schedules, which can be a big problem.
If the buyer feels the seller intentionally didn’t disclose information until the last minute, it can have a very negative impact on completing the transaction and the ongoing relationship between the retained members of the management team and the buyer.
What kinds of things can show up at the last minute?
Usually it is a problem the seller was trying to solve before he or she has to disclose it, but can’t. The seller discloses it in the schedules just before the acquisition agreement is signed to avoid later indemnity claims. But doing so at the last minute is a problem in itself.
Thomas Vaughn is a member at Dykema Gossett PLLC. Reach him at (313) 568-6524 or TVaughn@dykema.com.
When trying to learn information about an individual, many companies turn to online background checks to uncover or confirm information. However, doing so could prove a mistake if this is the primary step taken to understand an individual’s background, as relied upon information may not be fully verified.
Hiring a licensed investigator can not only help ensure high-quality information is obtained, it can also facilitate the analysis of this information to provide a complete picture of an individual, says Theresa Mack, CPA, CFF, CAMS, CFCI, PI, a senior manager with Cendrowski Corporate Advisors.
“A simple background check may provide an incomplete picture of an individual and overlook critical information,” says Mack. “By hiring a licensed investigator to conduct background due diligence, you can ensure that no stone is left unturned.”
Smart Business spoke with Mack about how a licensed investigator can help your business uncover the information you need and put it in an appropriate context.
Why should a company hire a licensed investigator to conduct background due diligence activities rather than perform an online background check?
Most online or database-driven background checks are actually ‘record checks.’ In other words, data from records is compiled and the quality of source information is not thoroughly verified.
For some purposes, this cursory check of public records may be sufficient. However, depending on the information found, the nature of the background check, the check’s intended use and the access to confidential/proprietary information that a potential employee may have, a complete background due diligence investigation may be warranted.
A background due diligence investigation, as performed by licensed investigators, is far from a cursory background check. No single record or method of search is generally employed; instead, an investigator uses multiple resources to verify data accuracy and corroborate information. Thus, background due diligence investigations help reduce the risk of client reliance on false information.
What process is employed by investigators to perform background due diligence activities?
An investigator generally works on a six-step methodology: prepare, inquire, analyze, query, document and report. This methodology is highly applicable to background investigations.
An accurate and comprehensive investigation is based upon existing, determined and verified information. Leaving no rock unturned and making every conceivable effort to locate all possible information is generally the objective of an investigator.
Investigators will tailor their activities to suit the needs of their clients, which typically include attorneys, businesses and individuals. Client needs will define both the records checked by the investigator and the type of documents that can be released to the investigator and the client.
Where will an investigator begin his or her research?
An investigator often begins the research process by examining open source information. In this instance, open source refers to sources that are overt and publicly available, as opposed to covert or classified sources; it is not related to open-source software or public intelligence.
Open source information includes public documents that are created over a person’s lifetime, allowing the investigator to follow a paper trail leading to a complete history of the individuals being searched. These may include court filings, property tax documents, vehicle registrations and social media sources, among others.
Open source intelligence is a form of intelligence collection management that involves finding, selecting and acquiring information from publicly available sources and analyzing it to produce actionable intelligence.
How does an investigator evaluate source information?
Any record that is kept or provided is only as good as the chain of events involved in its creation. While doing online record checks simply provides information on an individual, investigators are often tasked with evaluating the veracity of the source data.
Record maintenance, storage and dissemination procedures can often impact the accuracy of information. Typos, misprints and mistakes introduced by human error can also affect the accuracy of records. These latter items are often seen on personal credit reports, criminal convictions and even civil litigation histories, which, although they are official records can nonetheless contain errors.
Processes for updating records can also have an impact on the accuracy of information, as records are only as accurate as their frequency of update. Some records are never updated and may provide stale data if a user is unaware of this underlying issue.
Finally, the method data that warehouses employ for acquiring information critically impacts information integrity. For instance, the provider may have purchased information from a secondary source. In such an instance, it is essential that the provider have accurate retrieval processes and is knowledgeable about handling special data items.
Each of these issues is evaluated by an investigator over the course of conducting background due diligence activities.
Theresa Mack,CPA, CFF, CAMS, CFCI, PI, is a senior manager with Cendrowski Corporate Advisors. Reach her at (866) 717-1607 or firstname.lastname@example.org.
It’s a common mistake that business owners make: waiting too long to address an expiring commercial real estate lease. Sometimes the time just gets away from them. In other situations, they might even think they can sign a quick renewal and be done with it. Whatever the reason, waiting until the last minute is a sure way to leave money on the table.
“I am often asked by business executives when they should start addressing their expiring leases,” says Robert Chavez, founder and CEO of Guardian Commercial Realty. “While the answer varies depending upon circumstances, the time to start due diligence is much sooner than most expect.”
Smart Business spoke to Chavez about how timing is everything when renewing a lease.
Why is it important to begin early when addressing expiring leases?
I like to use the analogy of buying a new car to illustrate the answer to this question. Suppose you were to walk into a dealership, ask how much the shiny new car in the showroom cost, and then wrote a check for it a few minutes later. You would likely pay a lot more for the same car than your neighbor who visited the dealership several times, asked questions about other automobiles in the same class and then finally arrives ready to purchase at the end of the month when the dealership needs to make its sales quota. By doing some research, making the sales person (and likely sales manager at this point) aware that he has done his homework along with being patient and strategic, the neighbor saves many thousands of dollars purchasing the same car.
On a much larger scale, leasing or purchasing office space is similar. Tenants that wait until their lease is near expiration send a dangerous signal as their landlord realizes they are essentially out of options. They do not have time to negotiate another lease and relocate. Landlords take full advantage of this knowledge and hold to a high rental rate with little or no concessions. They are aware that the tenant has painted itself into a corner. When they are facing an expensive ‘holdover’ tenancy or threat of eviction, the landlord is able to leverage tenants into a bad lease. Waiting too long can easily cost a 10,000-square-foot tenant upwards of $600,000 in lost opportunity over a five-year term.
When is the optimal time to focus on an expiring lease?
My rule of thumb is 18 months on average. Longer for very large leases, and somewhat shorter for smaller leases or building purchases. I find that it generally takes most tenants longer than they anticipate to truly focus on important or sensitive internal issues that will impact their real estate decisions. Multiple parties may be involved in such decisions, which always require additional time. Business circumstances may also change and it is important to have ample time to react. I like to have at least three months, at the outset, to feel comfortable that a client has really come to grips with its strategy and direction. Once a tenant finally does decide what it wants to do, it takes much longer to convince a landlord to agree to an appropriate transaction. Landlord also have their own agenda and timetable, so it is imperative that ample time is allocated for landlords that are difficult and/or slow to respond.
Is there ever a time when due diligence is not necessary?
Many tenants feel that because they want to remain in their existing space that there is no need to conduct extensive due diligence. That is a big mistake. Landlords and their own agents talk amongst each other to understand who is active in the market. They also ascertain important information from furniture vendors, architects and others in the real estate support factions regarding which tenants are in the market. If tenants in their building are not on the radar, then landlords are less concerned about losing them to a competitor and important negotiating leverage is lost.
How can tenants make sure they have a strategic advantage during negotiations?
Astute tenants will take time to interview several real estate brokers. It can be a big mistake to assume that the broker they used last time is still a good choice years later. Once selected, a good broker will assist with:
- Site selections
- Evaluating and interviewing architects
- Touring space
- Drafting and negotiating material business points in proposals and letters of intent
- Reviewing construction budgets
- Aggressively negotiating key sticking points to close a transaction in the tenant’s favor
- Assisting legal with document critiques
There is even more work to do once a lease or amendment is signed, but understand that all these steps take time to properly complete. Once completed, and the tenant is now fully informed with regard to its choices, cost and risk, it is surprising how many do elect to relocate based on the data. I have had many instances where a client has stated firmly at the outset of a transaction that they will not relocate, only to see them jubilant over an opportunity that far exceeds their initial expectations.
As is typically the case, hard work does pay dividends. Fortunately for tenants, they can hire a real estate broker early in the process to do the majority of the legwork. Their brokers can spot changing market conditions that their client may miss, or find a unique opportunity perfectly suited to the tenant before it hits the open market. The sooner you get started, the more time you give your broker to work on your behalf.
Robert Chavez is the founder and CEO of Guardian Commercial Realty. Reach him at Robert.Chavez@guardian.net or (310) 882-2060.
It is a big decision to bring equity into a company. Typically, equity is brought in when debt alone is not appropriate or sufficient to satisfy the company’s needs. Equity can be minority or majority, and it can be structured in infinite ways. Regardless of the type or structure, this step also means that you are adding one or more partners. So, if you have the good fortune of being able to choose among two or more equity suitors, do your homework. The following are some things to consider:
Beware of the false minority (i.e., the devil is in the details). Minority equity often is viewed as more attractive because of the perception that “control” is retained. While this certainly can be the case, great attention must be paid to the terms of the investment, particularly to the rights of the investor in the event things don’t go as planned.
Frequently, minority capital will have performance hurdles or other identified events (like defaults under loan agreements), the failure or occurrence of which will give the minority investor greater rights and authority — sometimes control of the company. When bringing in minority capital, engage a qualified, experienced attorney and understand the rights you are giving away.
The power of the majority (i.e., it’s better to own half a watermelon than a whole grape). The remainder of this discussion will focus on investors who purchase 50 percent or more of the company. Your decision to accept equal or majority investment must also come with the acceptance that you now have a partner or partners and that there will be changes — ideally, for the better. A good equity partner can help create tremendous value. A bad equity partner can make your world miserable. At a minimum, look for these qualities in a potential partner:
Track record. Be sure that whatever you are hoping to gain from the partnership (other than capital) your potential equity partner has successfully done before. Whether it’s building a sales team, developing new products, cutting costs, developing infrastructure, going public, acquiring add-ons, franchising, etc., verify they have done it well. Study their track record, and ask the hard questions. If they are what they represent, they will respect your diligence. If they aren’t, you will, hopefully, avoid a mess.
Expectations. A good potential equity partner will spend considerable time with you and your team understanding your vision and making sure it aligns with theirs. When disputes arise between investors and their operating partners, it most often is the result of misaligned expectations. On the other hand, if done properly, the equity structure should be based upon your and the investor’s collective vision of the future.
Hands-on, hands-off. Prior to closing the investment, it is imperative that you and the potential investor agree regarding how you will work together. Some investors are only comfortable if they are deeply involved in operations. Others expect only to attend quarterly board meetings unless things go badly. We are in the middle. We like to spend significant time supporting development of the strategic plan, and then seek to support our operating partners any way we can in executing the plan.
Chemistry. Although hard to quantify, you should feel good chemistry with and trust for your potential partner. As you may be together a long time and face great challenges with your partner, this consideration should not be compromised.
A good equity partner can accelerate your growth and success and help you create and realize a vision far grander than you might otherwise have. A bad equity partner can be disastrous. Be disciplined, and choose wisely.
Dan Lubeck is founder and managing director of Solis Capital Partners, a private equity firm headquartered in Newport Beach, Calif. Solis focuses on disciplined investment in lower-middle market companies. Lubeck was a transactional attorney and has lectured at prominent universities and business schools around the world. Reach him at email@example.com or visit www.soliscapital.com.