Love is blind, so the saying goes. I’m certainly not going to suggest I’ve ever seen friends make questionable choices in their love life, but I have seen business buyers so enamored with an opportunity that they either ignored certain warning signs or willfully chose not to look.
Yes, as a business buyer you have to move quickly in today’s competitive market. (Be ready to put a ring on it, you might say.) But don’t let an initial infatuation keep you from doing your due diligence. Here are six potential blind spots that could cause you a lot of heartache down the road:
Financial adjustments: The seller and their team typically make adjustments to normalize EBITDA against any unusual expenditures or optional owner perks. But in some cases, the selling team gets a little too aggressive and starts adding back expenses things that you’ll still have in the future. Ignore $100,000 worth of add backs on a five-multiple sale and you’re paying an extra half million on the business.
Working capital: There’s profit and loss, and then there’s cash flow. I can count on one hand the number of times I’ve seen buyers and sellers agree on working capital with no negotiation. You need to understand how the seller’s business operates and how much “gas” (working capital) they need in the take to keep things running.
Revenue recognition: Long-term jobs present special problems for revenue recognition. How the seller recognizes revenue could impact EBITDA and other performance records. You need to understand the quality of the earning, and how much has been booked against ongoing projects, and the expenses you’ll incur as you continue to deliver.
Culture: You can’t find it on a balance sheet, but it could make or break your success. Pay attention to culture issues like customer service philosophies, innovation, risk, how decisions get made, flexible work, and employee benefits. Even if you’re buying 100 percent of the business, these issues matter to the remaining management and employee team.
Utech Group, a Green Bay-based consulting firm, offers a culture analysis tool called “illumyx” that I like to recommend. With a version designed specifically for M&A applications, it allows parties from both sides to investigate future culture alignment issues without risking confidentiality during the sensitive sales process.
Future turnover: Ask the seller about future employee retention. Is anyone near retirement age? Do any of the seller’s family members work in the business? If yes, what are their intentions to stay? Is the seller starting a new business and likely to lure away their trusted team? Talk with your advisor about stay bonuses and other retention strategies to keep key personnel on board.
Customer concentration: A growing sales trend is great. Just understand where all that growth is coming from, particularly if it’s just one customer. Dig in to customer concentration issues, and check trends over several years. Ideally, you want a stable and diverse base of repeat customers, with no one customer accounting for more than 10 to 15 percent of sales.
If there’s a large customer concentration issue, you might work with the seller’s advisor and conduct customer interviews to determine the stability and loyalty of those key accounts. Talk to multiple stakeholders at that account, including key decision makers as well as purchasing personnel.
An M&A transaction should involve a significant amount of due diligence by the buyer and their advisors. You need to confirm that the business is what it’s been presented to be, with sound financials, loyal customers and committed employees.
Joan Young has been assisting buyers and sellers in small businesses since 1980. Her diverse business experience ranges from manufacturing and distribution to retail, publishing, advertising, placement services, direct sales, as well as re-sales of franchise businesses. Committed to strong work ethics, Joan focuses on integrity and professionalism. Her goal is to achieve the desired results for both sellers and buyers. “Win-Win” best describes Joan’s approach to all of her transactions. She owned FranNet of the Bay Area from 1990-2014 and started Sunbelt Business Brokers Greater Bay Area in 2000.
Joan Young is the President of Sunbelt Business Advisors. She can be reached at (408) 436-1900, ext. 102 or at [email protected]