Now May Be the Right Time to Acquire a Business
The COVID-19 pandemic has resulted in financial losses for many businesses, including manufacturers. As a result, some owners may be looking for an exit strategy. In this uncertain market, some investors see opportunity. For those who are able, now can be a good time to acquire a distressed business with an eye to turning a profit. Here’s some guidance on this strategy to help you avoid potential pitfalls.
Looking at the Long Term
While turnaround acquisitions can yield significant long-term rewards, acquiring a troubled target can also pose greater risks than buying a financially sound business. The keys are choosing a company with fixable problems and having a detailed plan to address them.
Look for a company with hidden value, such as untapped market opportunities, poor leadership, and excessive costs. Also consider cost-saving or revenue-building synergies with other businesses that the buyer owns. Be sure to assess whether these opportunities exceed acquisition risks and potentially provide ample financial benefits.
Doing Your Homework
Successful turnaround acquisitions start by understanding the target company’s core business — specifically, its profit drivers and roadblocks. Without a clear understanding, you may misread the company’s financial statements, misjudge its financial condition and, ultimately, devise an ineffective course of rehabilitative action. This is why many successful turnarounds are conducted by corporate buyers in the same industry as the sellers or by investors (such as private equity funds) that specialize in a particular sector.
During the due diligence phase, pinpoint the source of your target’s distress, such as excessive fixed costs, decreased demand for products and services, or overwhelming debt. Then determine what, if any, corrective measures can be taken. Don’t be surprised to find hidden liabilities — such as pending legal actions or deferred tax liabilities — beyond those you already know about.
You also may find potential sources of value, such as tax breaks or proprietary technologies. Benchmarking the company’s performance with its industry peers’ can help reveal where the potential for profit lies.
Managing Cash Flow
Before completing a transaction, determine what products drive revenue growth and which costs hinder profitability. Does it make sense to divest the business of unprofitable products, services, subsidiaries, divisions or real estate? Should you cut staff?
Implementing a longer-term cash-management plan and developing a forecast based on receipts and disbursements is also critical. Cost-saving and revenue-generating opportunities, such as excessive overtime pay, high utility bills and unbilled services, can be achieved with a strong cash-management plan and a thorough evaluation of accounting controls and procedures.
Reliable due diligence hinges on whether the target company’s accounting and reporting systems can produce the appropriate data. If these systems don’t accurately capture all transactions and list all assets and liabilities, a potential buyer won’t be able to track progress and fully pursue growth opportunities or respond to potential problems.
Structuring the Deal
When buying a business, the parties can structure the deal as a sale of either assets or stock. Buyers generally prefer asset deals, which allow them to select the most desirable items from the company’s balance sheet. In addition, the buyer receives a step-up in basis on the acquired assets, which lowers future tax obligations. And the buyer negotiates new contracts, licenses, titles and permits.
On the other hand, sellers typically prefer to sell stock, not assets. Selling stock simplifies the deal, and tax obligations are usually lower for the seller.
However, stock sales may be riskier for buyers because the business continues to operate, uninterrupted, and the buyer takes on all debts and legal obligations. In a stock sale, the buyer also inherits the seller’s existing depreciation schedules and tax basis in the company’s assets.
Developing a Plan
Current market conditions make business acquisitions both tempting and tricky. Contact one of our M&A professionals to help develop a strategic plan that minimizes potential risks and maximizes your long-term value.