Commentary & Analysis
Gotcha! Heading Off the Hassles of Inconvenient Truths in M&As
Sometimes, sheer embarrassment can kill a merger—the shock of suddenly having to account for issues that ought to have been dealt with earlier in the process. Privately held printing companies can be prone to the kinds of errors that embarrass sellers and thwart M&As.
By Patrick Henry
Published: February 15, 2013
What kills attempts to merge printing companies? Sometimes, sheer embarrassment can do it—the shock of suddenly having to account for issues that ought to have been dealt with earlier in the process, but weren’t. The irony is that timely disclosure or corrective action would have rendered the problems moot. But, that’s no consolation to the red-faced seller after the disappointed buyer has walked away from the negotiating table.
In his role an M&A strategist for New Direction Partners (NDP), Thomas J. Williams has seen more than one situation in which faulty record keeping or delayed discovery has undermined what otherwise would have been a solid deal for both parties. He points out that privately held companies—unlike publicly traded businesses subject to reporting requirements—can be prone to the kinds of errors that embarrass sellers and thwart M&As.
A problem that surfaces during due diligence may be a problem that has come up too late to fix, Williams says. He advises prospective sellers of closely held printing companies to find and defuse “time bombs” that could go off during negotiations if record keeping has been careless or incomplete. Following are what he describes as the most commonly encountered deal-killers.
Faulty OSHA documentation. Buyers and investors will want assurances that mandated safety records—such as the annual OSHA 300 log for incident recording—are compliant and up to date. Williams adds that most printing companies use hazardous materials that must be documented for proper storage and handling. Buyers will treat errors and omissions in these records as liabilities.
Inadequate financial records. Doing the bookkeeping with off-the-shelf business management software may be fine for day-to-day operations, but it won't generate the kind of financial information a buyer wants to see. Williams advises engaging an accountant to prepare, at minimum, a reviewed financial report: a document certifying that a basic inspection of the numbers has been carried out. Better yet, obtain an audited report, a more thorough exercise that takes a “deep dive” into the financials and renders the accountant’s professional opinion of them. (A compilation report, the simplest type, may not satisfy potential buyers and their advisors, Williams says.)
Environmental issues with real estate. Maybe the property contains an underground fuel tank. Soil may have been contaminated by leakage of improperly stored chemicals. If real estate is to be part of the transaction, says Williams, it’s the seller’s responsibility to identify and address problems like these before they become obstacles to completing the deal. At minimum, a buyer and his lender will require a Phase I environmental report.
Lawsuits and judgments. Because legal outcomes have a direct bearing on the condition of the business being acquired, the seller must inform the buyer of pending suits as well as adverse judgments. This type of information, notes Williams, won’t likely be found in unaudited financial reports.
“Ghost” payrolls and benefits. If, for whatever reason, payments are being made to individuals—including family members—who aren’t bona fide employees, this should cease immediately. The same goes for “ghost” benefits in the form of non-employee insurance, auto use, etc.
Problematic customer concentration. “Don’t hide the fact that 40% of your volume comes from one client” if the business is concentrated that way, Williams counsels. It’s essential to be up front with buyers about the purchasing hierarchy of the account list.
Undisclosed shareholders, equity investors, and partners. Williams recently took part in a transaction where due diligence had been completed, an agreement had been drawn up, and everything seemed to be going well—that is, until “an undisclosed partner came out of the woodwork” making unreasonable demands that ultimately sank the acquisition. “All persons in a position to veto a deal must be in the loop,” he says. “There should be no surprises after a deal is baked.” He adds that family-owned businesses frequently include non-active stakeholders who can emerge at the eleventh hour to kill a deal.
“Unqualified leases” and similar off balance sheet financial arrangements. Sometimes, businesses account for debt by incorrectly recording it as a lease—an ordinary expense. But, for the sake of a successful M&A transaction, debt must not appear in financial reports as anything except what it is. The due diligence stage would be a highly inopportune moment for a buyer to discover for the first time that the seller is carrying debt that is not properly reflected on the books, Williams says.
Worthless inventory and obsolete assets. Buyers won’t be pleased to find superannuated skids and rolls of paper and other obsolete inventory sitting in the warehouse and carried on the books. Obsolete, underutilized, and sidelined equipment creates the same kind of negative impression. Williams says that if the seller’s shop has machinery that looks like it “ought to be in a museum, but not in a printing plant,” it’s probably equipment that shouldn’t be there when buyers come to inspect the premises.
“Clean up your act,” Williams urges sellers. Better to confront the aggravation of fixing hidden problems now than the angst of trying to explain them to a buyer later.