Aug 2, 201811:36 AMExit Stage Right
with Martha Sullivan
Why the motto 'Be Prepared' applies to your business
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No doubt you’ve heard the motto “Be Prepared.” “Be Prepared” urges you to be ready to do the right thing at the right moment, always. The motto holds water in all aspects of our lives, whether or not you were a Scout at some point in your life.
As a business owner, this is true for your business, as well, so that you and your company are ready to handle whatever opportunities or issues that arise. The consequences of not living up to “Be Prepared” can be significant. I’m working with a client looking to acquire a manufacturing company and this hit home in a striking example this past month.
The target manufacturing company has a unique place in its market, a good team of employees, and many things a buyer might be interested in. The owner has lost interest in the business. He has other pursuits that he wants to be involved with, so he is ready to sell.
A deal has been struck, and both buyer and seller are looking forward and motivated to close the transaction soon. Unfortunately, the target close date will be delayed due to the seller’s lack of a “Be Prepared” attitude. As you’ll see, some of the preparedness issues will cost the parties in time delays and opportunity cost. Other issues may directly impact the economics of the deal. Consider the following issues, all of which could have been avoided:
- State of the inventory records: The seller runs his inventory system through a series of Excel spreadsheets, performing a periodic physical inventory. There is no integration between an accounting module in the accounting software and the spreadsheets. The Excel spreadsheets do not reconcile with the numbers reported in the financial statements by six figures. The balance sheet is overstated.
In a deal that has a working capital target to be met, this is problematic. It also calls into question the accuracy of the historical financial reporting. Where did the other side of the error land? If it is in the income statement, the entire earnings before interest, taxes, depreciation, and amortization number is off, which is then magnified by the multiple. This will give any buyer pause and cause them to reconsider their purchase price.
- State of fixed asset records: The shop floor houses many different pieces of manufacturing equipment, all of which are being purchased by the buyer. Two weeks before the scheduled close date, the seller realized that there were items on the shop floor that were not included in his fixed asset records despite the fact that the items had been used for a number of years. There were also pieces of machinery and other capitalized items that were in the records and on the balance sheet that were no longer in use and had been disposed of. Lastly, there is a major piece of equipment that the seller believed had been fully depreciated but actually had not been depreciated at all. Hundreds of thousands of dollars are entangled in these fixed assets issues.
The buyer is purchasing the assets. The lack of accuracy in this area is a big deal, particularly when it comes to knowing what is really there, what’s being purchased, and assigning a fair market value to the equipment in the purchase price allocation.
- Availability of key legal documentation: When a transaction is an asset deal, the seller’s contracts and agreements don’t naturally flow to the buyer. Each agreement needs to be reviewed for its change of ownership clause so that steps can be taken to ensure relationships and rights are transferable and can be transitioned in the most effective and efficient manner possible. In the event an agreement can’t be transferred, the buyer needs to know this up front so that arrangements can be made, or other steps taken. In this particular deal, no documents have been provided for review. It’s unknown as to why — is it because there aren’t agreements (which is unlikely given the nature of the customers involved) or is it that the records are in disarray and not easily retrieved, organized, and delivered? Whatever the reason, it does not bode well for the deal.
Further, the seller was involved with a transaction several years ago that has a direct impact on the rights surrounding intellectual property. The buyer rightfully wants to have confidence that the intellectual assets he is purchasing are unencumbered and has asked for counsel to review the legal documents associated with this prior transaction. The seller can’t find the document. The attorney that handled the transaction retired. The deal will not get done without this review.
There is now, two weeks prior to close, a scramble underway to track down executed copies of documents. Without clarity around the intellectual capital, and transferability of customer and other agreements, the whole deal could blow up.