Media Center

January 7, 2016
Publications

By Salvatore J. Bauccio

Marcellus Shale drilling was taking off, and the owner of an oil and gas service company fielded a buyout offer from a Wall Street private equity firm. Golden opportunity, right?

Wrong. In mergers and acquisitions, there are pitfalls that buyers and sellers must avoid. The company owner fell into too many of those traps, while the private equity firm adhered to the rules. The result was a bargain for the buyer and a washout for the seller.

The M&A market is red hot. Firms are emerging from the recession with lean operations that have built up cash reserves. Fuel costs are down, and so are interest rates.

With cash on hand and easy access to debt, companies are finding an optimal climate for buying and selling, but the process requires attention to detail.

5 mistakes that can burn even the best looking deal:

1. Signing agreements before talking to an attorney

This was the Marcellus business owner’s first mistake. Typically, the first step in a merger or acquisition is signing the “terms sheet,” which spells out such material business terms as purchase price, length of time for due diligence, license transfers, and conditions for bank financing. Because they’re nonbinding, parties often sign without consulting attorneys. But bad faith can be generated by reneging on the terms.

Solution: Consult an attorney prior to signing a term sheet (even if it is “nonbinding”).

2. Sloppy financial reports

Companies being acquired, including the Marcellus business owner, commonly make this mistake. Buyers put a value on the company based on the balance sheet and income statement. How much cash flow does the business generate? How much is forecast? Jumbled financial statements cultivate fears of unpredictable performance and enable the buyer to angle for a discount.

Solution: Have financial statements prepared by a certified public accountant.

3. Failure to conduct due diligence

Buyers should investigate their target companies to avoid unpleasant surprises. They must inspect real estate and inventory, scrutinize financial statements, review contracts with customers, examine employment records, conduct lien searches, and do environmental site assessments.

Solution: Caveat emptor – buyer beware.

4. Lack of recourse if the agreement is breached

Even the most meticulous due diligence won’t uncover potential problems if the seller supplied incorrect information. If the terms of the sale lacked any recourse, the buyer must pay attorneys’ fees to recover losses, or is just out of luck.

Solution: Buyers can establish escrow accounts withholding part of the purchase price for a time. In the case of a breach, the buyer can access the funds to be made whole. Sellers can also sign personal guarantees, perhaps leveraging real estate or a mortgage. In the case of the Marcellus business, the private equity firm withheld a large amount of cash proceeds in escrow following the sale, and subsequently “clawed back” that cash when it turned out that the seller’s financial statements were sloppy and misleading.

5. Failure to contract a business valuation expert

To a seller, a $10 million offer can seem tempting, but does it account for the value of real estate, cash flow, and brand recognition? Sellers who don’t know their business’ full value can sell themselves short. Conversely, buyers can lose out if they swallow the hype and don’t get their anticipated returns.

Solution: Hire a business valuation expert who knows the nooks and crannies of the industry.

Remember that mergers and acquisitions can take time, especially if they require third-party approvals, such as government antitrust clearance or the manufacturer’s blessing in a franchise dealership sale. Be sure to work with professionals who can prevent major mistakes and craft a deal that benefits everyone involved.