June 2004
By JAMES S. ANCHIN, CPA
Just as in other industries, it often makes sense for contractors to acquire or merge with other companies to expand their presence, add lucrative new services and boost their bottom line. Unfortunately, the drive to make a deal happen can often cloud judgment and plunge the acquiring company into a potentially ruinous situation.
A contractor may have identified for purchase a company that represents either vertical or geographic expansion. The target company has a good reputation, a similar corporate culture, top-notch employees and a valid reason for selling. The preliminary financial analysis is coming up favorable and the enthusiastic buyer and seller are pressing for a quick deal. In this scenario, it appears that "all systems are go."
Due Diligence
In fact, the best course of action in this instance is to slow down and exercise due diligence. Careful due diligence is an integral and extremely beneficial part of the entire mergers and acquisition process and it can weed out bad deals early on, preventing further time and expense to both parties. Proper due diligence can also head off potentially devastating litigation.
A major reason that mergers do not succeed is because due diligence failed to turn up irregularities in the target company. Think of due diligence as risk management. With very little margin for error in a merger or acquisition, due diligence should begin before any negotiations between the two companies and continue every step of the way, right through to the day the deal closes.
What Due Diligence Entails
Proper due diligence means gathering information. Attorneys and accountants for the acquiring company will assemble a vast store of information about the acquisition target that will ultimately form the basis of the purchase price, the terms of the transaction, how the risk will be allocated and a variety of other extremely pertinent factors. Contractors should make sure their due diligence involves the full investigation of all the typical pitfalls, information on the target company's accounting practices as well as any pre-existing environmental conditions, tax liabilities and litigation. Unknowns in these areas can represent hidden costs that keep you from achieving your financial and corporate goals.
For example, after completion of due diligence, you should know what's in all the agreements the company has made with other parties. That is carefully studying the details of pacts with joint venture partners, vendors, sureties, lenders, etc. Failure to read and understand the fine print can leave you holding the bag, or foregoing an opportunity to make certain tasks part of the acquired firm's closing obligations or to whittle down the purchase price. For contractors, no due diligence would be complete without an analysis of the target company's current and future jobs. Contracts for jobs in progress Ñ and for the company's backlog Ñ should be analyzed by the attorney, the accountant and the buying company's management.
Proceed With Caution
Be aware of any pending litigation Ñ meritorious or otherwise Ñ or arbitration faced by the company you're considering to acquire. In our litigious society, it's just plain reckless to take a chance on inheriting your merger partner's lawsuits and winding up in court after the deal has been inked. Relatedly, make sure your due diligence covers compliance issues. Does your acquisition target have noncompliance issues with local, state or federal agencies? In the contracting industry where regulations abound, a target company's failure to comply with permitting or environmental regulations could derail the success of a transaction. What about contaminated land or buildings held by the target company? If contamination is an issue, you must determine who will be footing the bill for clean up and when. Environmental exposure is always a hot button and one that can be leveraged to dramatically reduce the target's price tag.
Due diligence is best conducted as a team effort, with accountants, investment bankers and other consultants all having a role in making a successful acquisition happen. To get a well-rounded picture of the target company, its top executives should be interviewed and their references checked within the industry.
Don't be put off by the costs of due diligenceÑreal or psychological. Naturally, the chief executive officer and senior management may have a vested interest in pushing the deal through, and may also be getting the hard sell from the seller or investors. But taking a rational and dispassionate approach is critical if you're going to make the kind of deal that will help the company grow and develop in the future.
About the author: Mr. Anchin is a managing partner of Anchin, Block
& Anchin, LLP, a regional certified public accounting firm with offices in
New York City and Westchester, that specializes in meeting the needs of
contractors in the tri-state area. He can be reached at (212) 840-3456 or by
e-mail at: james.anchin@anchin .com