Matters Column

Thinking about an acquisition? Discard the rose-colored glasses

November 6, 2015
| By Scott Hill |
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Like many things in life, beauty is typically in the eye of the beholder for business acquisitions, so it helps to have a good pair of clear glasses to help one see.

If an acquisition makes sense for your family business, internal and external advisors can help with due diligence and areas of concern. You can and should encourage your advisors to serve as lenses for you. 

Secure a strong deal team. Typically, a deal team will consist of a lawyer, accountant, banker and business analyst with significant transaction experience. Acquisition experience of all deal team members is critical, as their role is to challenge assumptions, identify potential problems and propose mitigating solutions.

Regardless of the composition of your team, encourage your advisors to communicate regularly during the acquisition process — with you and with each other. Implement periodic check-in calls to keep everyone informed and on task. These connections can eliminate duplicate work and help reduce transaction fees.

Get beyond the numbers and seek the why. Once an acquisition target has been identified and you have begun the due diligence process, do get beyond the P&L to investigate. Utilize your advisors to challenge why you believe that target is the one to consider. If you have more than one target, do the same review for each and compare.

Be sure to consider whether the "why" syncs with your business in an accretive way. It may be helpful to have early meetings with key customers and key suppliers of the target to understand why they work with the target. Keep in mind that sellers will often resist such interactions until late in the due diligence process, but will allow them prior to closing in most cases.

Balance risk with opportunity. Involve your external advisors to identify risks and require them to provide y alternative solutions to balance those risks with opportunity. Remember, you don't have to have all of the answers, especially if this is the first time you are acquiring a business.

If the target is an early-stage company at the start of an exponential growth curve, you might consider spreading the purchase price over a longer period of time through an earn-out, whereby the target's owners can make more if projections prove to be true. You might consider using seller financing with extended payments or a holdback with right to set-off if the target's owners make misstatements during the transaction.

Rep and warranty insurance continues to grow in popularity; however, it is an expensive product which limits its application for smaller sized transactions. 

Dig deep in due diligence. While no two deals are alike, every target will have key contracts, such as supply agreements, leases, services agreements, license agreements or otherwise. These key contracts may contain language requiring the target to obtain consent to transfer them to a buyer in the event of a sale. 

Understanding these triggers is essential so that steps can be taken prior to the closing to avoid unintended consequences. It is not uncommon for third parties to hold a transaction "hostage" if parties wait too long to obtain consent. Your advisors can help you navigate this issue and negotiate solutions.

Be creative with transaction structure. Transactions can be structured in a multitude of ways, whether it is a stock purchase, asset purchase, merger, joint venture, etc.

One feature that is used with some regularity is to allow the target's owners the right to rollover a portion of its ownership in the target to the new company. This technique is more common when the target's owners will remain active in the business, but it can help flesh out the owners' perspective on the business and its likelihood for future success.

Be mindful of culture shock. Culture is paramount in a family businesses; it is a key component of sustainable success. 

There are four basic approaches to establishing culture following a transaction: (1) assimilation — where the target adopts the buyer's culture; (2) correlation — where two cultures are maintained without overlap; (3) integration — where both sides share the best of both cultures but otherwise remain independent; and (4) creation — where an entirely new culture is created.  

Your ability to implement your selected approach is as important to the future success of the business as the strength of the target's P&L or revenue prospects. Consider carefully whether the target's culture will be complementary or disruptive. Training and regular communication regarding your family business culture will help new employees assimilate faster during the early stages of "life after acquisition."

Have a communication plan. When you make it to closing, do consider how you want to announce the transaction both internally and externally.

Often it is beneficial to work with the target to jointly give the message. If no message is given, the parties run a greater risk of not being able to control the dialogue, because when a transaction occurs, people will talk and rumors may spread.

What will you say to family members, employees, customers? Think about the questions they will likely have and be prepared to communicate your answers when the transaction closes.

Be willing to say no. Many owners selling their business do not want their employees to know about a potential transaction until the closing, which makes it difficult to evaluate a target. At some point, however, you must evaluate how your team will mesh with the target's team. Identify non-negotiables and be comfortable saying no to the deal if cultural integration just won't work, even if the numbers look great.

There are many targets in the current market and growth through acquisition can be an effective strategy. If the time is right for you, start the discussion with your advisors.

Varnum attorney Scott Hill focuses his practice on general corporate law, succession planning, and mergers and acquisitions for family and privately held businesses.

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