March2006

As the economy continues to grow, merger and acquisition activity is on the increase and not just at the multi-billion dollar level. More entrepreneurial firms are actively seeking and making acquisitions ranging from under a hundred thousand dollars to $20 million.

Any entrepreneur seeking growth for his or her firm essentially has two options: organic growth and acquisitions. The first has nothing to do with lack of chemical pesticides and fertilizers. It refers to company growth in the manner we usually understand it, acquiring new customers and/or increasing business with current customers. Growth through acquisitions means acquiring, usually buying, another company in the same or similar business as one’s own.

Since most companies strive for organic growth whatever the circumstances, the choices for growth really come down to a) organic growth alone or b) organic growth together with acquisitions. The better choice depends upon one’s overall strategic plan and exit strategy. Let’s say the owner of XYZ Corp wishes to sell in 15 years for $20 million. This will likely require earnings before interest, taxes, depreciation and amortization (EBITDA) of at least $4 million to $5 million. If organic growth alone will not likely achieve those kinds of earnings, acquisitions will need to be made.

In other cases, one might want the firm to stay in the family indefinitely, but growth in excess of a realistic organic rate is necessary to remain competitive and to avoid being acquired by a larger firm. For other entrepreneurs, who are not clear on their strategy, one or two experiences in making acquisitions gets them hooked on the “thrill of the hunt,” and restores the sense of excitement and risk that motivated them in the early days of the firm’s life.

Whatever the motivation, making acquisitions successfully—and avoiding buyer’s remorse—requires gaining a whole new set of skills and insights to avoid getting lost. Having helped a number of clients through this process, I share the following guidelines and observations to help avoid deadends and worse in the maze of events the process entails:

Have realistic expectations of the seller’s broker. If the target company is listed by a broker, remember that he or she has only about a 20-25% chance of actually selling the business. California requires business brokers to have a real estate license, yet the average small business sale nets a smaller commission than the average home sale. Additionally, businesses are typically on the market for six to 18 months. Bottom line: to make a good living, a business broker needs a huge inventory and not to devote much attention to any one item. Consequently, there is high turnover in the field, many brokers have little experience, and 98% of the educational material for the real estate exams deal with selling homes, not businesses.

Be skeptical of valuations. Businesses are too unique to be assessed based on comparables as houses are. Valuations can be done for various purposes, such as tax liabilities, divorce settlements, estate distributions, and so on, and each purpose may produce a different outcome. Professional assessors will charge you up to $10,000 per small business valuation to provide information that you or a sharp assistant can glean from a couple of hours on the internet. Lawyers and CPAs who are regularly involved in such transactions can be a much better source of real market prices.

Hire a CPA experienced in acquisitions due diligence, to verify the numbers. A minimum of the last three years’ tax returns should be available from the seller. Some sellers claim to take money under the table and will assure you that actual revenues are way above what the returns show. They are saying in effect, “I lie every year to the IRS, but you can trust me to tell you the truth!” Unless you can easily confirm this, walk—no, run—away. If you decide to risk doing the deal anyway, make sure you will not incur past tax liabilities and be prepared for other nasty surprises.

Remember the adage, “lawyers are deal-breakers, not deal-makers” (with apologies to my lawyer friends). It is clear why this is sometimes the case. Lawyers are duty-bound to give you advice that minimizes your risk. The least risk is incurred by you if no deal is completed at all. Further, this also minimizes the lawyer’s potential liability, while he or she still gets to bill for hours. The best legal advice is not always the best business advice, and all acquisitions carry risk. You need a good lawyer to draw up and sometimes to negotiate the Definitive Agreement, but let your lawyer know clearly that you are in charge and what your objectives are.

Have Human Capital Due Diligence performed as well and not just on personnel administrative issues. To cite one case study, a client of ours had decided to acquire a manufacturing company and wanted to promote one long-time supervisor to plant manager. HC due diligence uncovered the poor opinion most workers had of this individual, averting a potentially very costly mistake. Rampant fear of layoffs among the work force was also uncovered to the buyer’s surprise, since they wanted all employees to remain in place. The buyer was subsequently able to proactively retain key staff and ensure a successful acquisition.

Establish relationships with bankers ahead of time if you plan to finance the deal. Bank of America does the most SBA loans in Los Angeles County. On the other hand, smaller players such as Comerica Bank have established reputations as being particularly interested in small business transactions. You may also want to contact your Small Business Administration office for advice.


	Mulkern Associates is a privately held consulting firm of Anthony J. Mulkern