Diligence required to improve company value Featured

1:54pm EDT June 4, 2012
Diligence required to improve company value

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.

Business Succession

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 sfields@bkd.com.

Article reprinted with permission from BKD, LLP, www.bkd.com.  All rights reserved.