Ever hear “I sure wish I had known ___” from a fellow business owner shortly after their last acquisition? Because acquisitions are an emotionally charged activity, with the excitement of increased profits often overpowering good sense, be especially alert for red flags before you buy. Think of the due diligence process a little like dating – use the time to explore whether you really should be married, not just charge forward to the goal. Here are some good ones to watch out for:
1) “Revised” P&L data – During initial talks, a seller’s summary P&L’s are fine. But the seller may be leaving out legitimate costs. By due diligence, insist on unedited internal financial statements, even though they will likely include expenses you won’t have (the current owner’s kid’s salaries, his wife’s vehicle and insurance, etc.). To be fair, ask the seller to provide you with a list of unnecessary or non-business related expenses for pricing purposes.
2) Unrealistically Low Maintenance and Repairs. Some sellers defer repairs and maintenance. Although this boosts EBITDA temporarily, it can result in unforeseen repair bills for an unsuspecting buyer. You know your own repair costs. If the seller’s seem low, start asking questions.
3) Hidden Potential Bad Accounts – Most purchasers know to use an escrow for potentially uncollectible receivables, but may neglect review of all “significant” account credit files. Don’t let a good receivables aging fool you. Have a competent credit person analyze major accounts.
4) Inventory surprises – Many a buyer has been faced with discovering unidentifiable drums in the back of old warehouses! Verify exactly what is on site by the time of the transition. Refuse obsolete inventory, and require the seller remove any unwanted items within 24 hours.
5) Significant new profits or lower costs needed to justify price – No matter what a seller thinks his business is worth, never pay for what you bring to the table in lower costs or operational proficiency. The only time you should pay a premium over current profit value is to keep out a potential competitor. If that competitor could wreak havoc on your own company’s profits if you allow them into your marketplace, the premium becomes very justified!
Stay alert to these common red flags. Thorough due diligence (much more than just the big ones mentioned here!) will minimize your chance of painful surprises. You’ll be able to brag about your acquisition, instead of lamenting about the unpleasant surprises.
Meridian Associates has been partnering with family-owned businesses for over 30 years to remove barriers, accelerate business growth, build their legacy, and reduce stress levels. With three, high-impact business events each year, The CEO Exchange, Women in Family Business, and The Family Business Intensive, we continually provide best practices & proven strategies that keep multigenerational businesses thriving. Discover how Meridian can help your business thrive through our combination of high impact business coaching, advisory, M&A, and precision company valuations by visiting www.askmeridian.com or calling us at 817-594-0546.
