Business owners decide to pursue acquisitions for a variety of reasons. A longstanding company with a mature product line may want to jump-start its performance. The owner has three options: invest in internal product development, partner with alternative suppliers or acquire a business with a suite of complementary products.
A company with a strong local presence may be interested in expanding geographically. The owner can either try to build a presence from the ground up or acquire an existing business in the target location.
Or perhaps a company believes there is an opportunity to sell its existing products or services to a new industry. The owner can expand his or her existing business development function or purchase a business with a foothold in the target industry.
These scenarios underscore the importance of understanding strategic objectives before embarking on an acquisition
“You must know what your endgame is before you can determine whether acquisitions will help you reach your goals,” says Chris Meshginpoosh, Director, Kreischer Miller, Horsham, Pa.
Here, Meshginpoosh discusses with Smart Business the key considerations when buying a business, including due diligence procedures and red flags.
After an owner determines that an acquisition is the best way to reach strategic goals, what’s the next step?
Targeting businesses for acquisition can be a full-time job, and a lot of companies don’t have a corporate development function in-house. If an aggressive acquisitions strategy is critical to achieving your company’s objectives say you want to be in five new countries in the next five years you will want to devote resources to the targeting process. In these circumstances, owners can bring in a team or outsource to an organization with the resources to identify potential targets.
What counsel should owners seek when performing due diligence on target companies?
There are two sides to every due diligence assignment. First is financial due diligence, which includes evaluating financial performance, business trends and other financial representations made by the seller. Here, either your accountants or accountants with experience in the target industry are great resources because they know the value drivers in your business.
Second is legal due diligence, the importance of which can’t be understated. Accordingly, it’s critically important to make sure that you engage legal counsel with extensive merger and acquisition experience.
What red flags signal that a target company isn’t a fit?
This depends on the objectives of the buyer and the nature of the industry. But I think it's always a good idea to find out the sellers’ expectations about continued involvement in the business. Do they plan to retain any ownership? Will they exit the business entirely?
If you don’t have management capacity to immediately take the reins and execute the integration plan, be wary of a seller who does not offer to provide active, transitional management or consulting for a period of time. A seller that retains some ownership or better yet, leaves some of the purchase price at risk is probably more comfortable with the company’s ability to achieve its goals.
What financial warning signs should owners scrutinize?
Look for one-time or nonrecurring transactions that have driven recent earnings. Steady growth is easy to analyze, but be suspicious of anomalies. Has a stable business shown a recent surge in financial results? The spike in results may be due to a one-time sale to a customer or a change in the way the company is selling its product or recognizing revenue, or it may infer that the company has simply depleted its sales pipeline.
What earnings line items should the seller be asked to explain?
If a seller says there are ‘add-backs,’ find out whether those are truly costs that will not occur after the sale of the business. For instance, in valuing a business, it might be reasonable to add-back payroll expenses for the relatives of the owner who are not active in the business. However, if the payroll costs relate to a relative who performs services critical to the business, adding back the costs is probably inappropriate.
When should an owner walk away from a target?
It’s always a good idea to set a maximum price before negotiations begin. Far too often, buyers get caught up in the momentum of the transaction and gradual accommodations on deal terms end up eroding post-deal returns. If you set a price limit and you can’t reach an agreement without exceeding your maximum, then sometimes the best answer is to walk away. In addition to price, it’s always critical to objectively evaluate the feedback of financial and legal due diligence advisers to ensure that you don’t jeopardize the strength of your existing business by purchasing the wrong business or the right business on the wrong terms.
CHRIS MESHGINPOOSH is a Director in the Audit and Accounting Group at Kreischer Miller, Horsham, Pa. Contact him at (215) 441-4600 or firstname.lastname@example.org.