8 questions to consider in M&A deals
With priced-right sales opportunities ripe for the picking, some of your customers may be tempted to acquire another business as the economy mends. Others — those feeling the strain of the prolonged downturn — may be considering a merger with another, stronger business.
In either scenario, you may be asked to provide financing. Here are some questions to consider as you sort the potential winners from losers in a merger or acquisition deal.
1. What are your borrower’s strategic motives? Before devoting substantial resources to due diligence procedures, identify the borrower’s strategic motives for acquiring another company. For instance, is it seeking economies of scale, production synergies or personnel from the deal? Acquisition targets that won’t accomplish the borrower’s overall strategic goals are a poor fit.
2. Does your borrower have a competent due diligence team? Problems may not be apparent to borrowers in an acquisition mode. In the midst of negotiations, due diligence can help your customer gauge success or failure. Business owners typically put together a due diligence team with managers from their company’s functional departments. These in-house experts can help assure lenders that all risk factors and contingencies have been addressed.
3. Are you satisfied with the due diligence findings? Before approving the loan request, determine what procedures were used in the due diligence process, and make sure you’re comfortable with the due diligence team’s performance. When due diligence is performed too hastily or its scope is too narrow, the borrower may overlook important risk factors, such as contingent liabilities, concentration risks and employee retention problems.
4. What’s the financial forecast? To get a sense of the acquisition target’s historic and future earnings, the due diligence team should make sure income and cash flow projections are complete and reasonable. Balance sheet items also should be investigated, and assets inspected to evaluate overall quality and obsolescence. Contingent or unrecorded liabilities, as well as whether the company is complying with federal, state, sales and employment tax obligations, also should be examined.
5. Have operations been properly analyzed? The due diligence team should tour the target’s facilities and, if possible, interview key personnel, customers and suppliers. The goal should be to identify company-specific risk factors, including obsolete assets, concentration risks and poor internal controls. The borrower’s production manager should flowchart the target’s production process on site to identify core competencies and operating maladies.
6. How does IT fare? The business’s IT should be up-to-date and compatible with the borrower’s systems. When the target company must integrate new IT systems, it will take time and money to get the seller’s employees up to speed. Postmerger IT integration requires a detailed action plan to avoid business interruptions, such as delayed deliveries and lost purchase orders.
7. What about human resources? Among a company’s most valuable — but transitory — assets are its employees. The compatibility of corporate cultures is key. The due diligence team must review the target’s HR policies and determine how salaries and benefits will change after the proposed merger or acquisition. To improve employee retention and guarantee the seller’s ongoing cooperation after the deal closes, employment contracts, noncompete agreements or consulting arrangements also must be reviewed.
8. What are your customer’s postmerger expectations? Beware of the unrealistic. Purchase prices are typically based on projections of future income streams, including future cost savings and revenue opportunities. Many transactions fail because purchasers overestimate acquisition synergies and economies of scale. Borrowers also may overlook the full costs of improving production or integrating two companies into one. Make sure your customers devise detailed action plans.
Delap CPA is a leading CPA firm serving Portland Oregon and the Pacific Northwest. Delap is a member of The Leading Edge Alliance, a global network of leading accounting firms. Delap was founded in 1933.
