No one likes surprises, especially in merger and acquisitions (M&A) deals; there are enough unknown variables to start with. As the deal progresses, tensions start to rise, so any additional variables can cause a disproportionate response. Below are some ways to avoid surprises, and how to deal with them when they come up.
The best way to avoid surprises is to prepare in advance as much as possible. An owner may think they know their business, but no one can know everything. Some sample items to focus on are:
- Conduct presale due diligence so that close corporate, legal, and other issues are disclosed from the beginning or rectified before even starting the process
- Run a Uniform Commercial Code (UCC) check. There may still be an outstanding lien that was never released on that drill that purchased in 1970
- Have your attorney check customer, supplier, and other contracts to see if any need to be updated or have a change of control clauses
- Presale quality of earnings reports are becoming more popular, so consider having a CPA firm perform this report to disclose potential accounting issues and risks for a buyer (audited financials for at least three years would be preferred)
- Conduct an independent customer survey, which can reveal both positives and negatives with customer relationships
- Conduct Phase II environmental testing. Many buyers will ask for this anyway, so you might as well get it out of the way. At a minimum, periodically conduct Phase I testing or have an environmental consultant conduct a review, which will show potential risks
- Utilize IT consulting and data backup. Many buyers will be concerned about how sensitive customer and company data is handled. If internal systems are too old, it may affect a company’s value
- If you have a landlord, their consent will most likely be needed for a buyer to take over the lease. Moving a PCB shop is nearly impossible, or at least very time-consuming and costly, so it’s important to know if the landlord will support the deal
By looking at ways to avoid surprises before they become surprises, an owner can avoid issues that should have been known. There are not many things more embarrassing than finding something out from a buyer that the owner should have been aware of.
No business is perfect; even Fortune 500 companies have issues. Disclosing negative sides of the business is important. The buyer will eventually find out, and it’s better if the seller discloses these matters in advance. Disclosing negative items shows credibility, and the seller can describe the issue in their own terms. For example, the lack of a sales team is an opportunity for a buyer to grow by investing in sales resources. Try not to overhype the business, as savvy buyers may see the hype as a way to cover up issues.
If surprises do come up during the M&A process—and they will—disclose the issues quickly and fairly, and propose solutions. Some examples might include:
- The largest customer announces they are being acquired
- Health issues, such as the owner or a key employee having a sudden health issue
- Sales and/or profits drop, which is probably the most common and worst surprise. Improve forecasting by staying in touch with customers and the sales channel
- A fire or disaster (maybe insurance will pay for new equipment?)
- External shocks, such as a trade war or a drop in the overall market
- Regulatory issues, such as a new regulation being announced, or one may pop up that no one had heard of previously
- Lawsuits, employee issues, or product returns/warranty claims
Issues always come up, but experienced buyers and advisors have seen (almost) everything. As long as the issue is disclosed quickly, both parties can try to find a solution. If a buyer really likes the business, they will be open to a fair solution. That being said, surprises may increase the time and cost of a deal. Time kills all deals, so avoiding delays is important.
Of course, good surprises happen too. Unfortunately, good surprises usually do not give a seller as much of a bump in value as bad surprises deduct from value. This is because buyers are typically skeptical to begin with, and any bad surprises just seem to justify their skepticism. Good surprises include a jump in orders and sales, favorable market conditions, a government regulation that favors the company, etc.
Keep in regular touch with the other party/buyer to make sure there are no surprises on their side. If things go quiet without advance notice, there is probably an issue. Keep the other side to a schedule, and let them know in advance if you are going to be out of the office for more than a day or two.
The biggest shock in M&A deals is if there are no surprises at all. Prepare to be surprised, which will make it easier to deal with the twists and turns of the M&A process.
Tom Kastner is the president of GP Ventures, an M&A advisory services firm focused on the tech and electronics industries. He is a registered representative of StillPoint Capital, LLC—a Tampa, Florida member of FINRA and SIPC—and securities transactions are conducted through it. StillPoint Capital is not affiliated with GP Ventures.