Understanding and Mitigating M&A Buyer and Seller Risk
By Brian P. Sullivan, Managing Director and Drent J. Shields, Managing Director
There are several risks when looking at both buying and selling a company, with the most apparent risk being financial risk – either overpaying as a buyer or being undervalued as a seller.
Beyond that, however, are some more serious risks often overlooked, including:
- Taxation risk
- Tax structure of the deal
- State and Local Tax (SALT)
- Unidentified liabilities and exposures
- Stocks versus assets
- Capital gains tax
- The time and money spent on the deal
A significant amount of time, energy, and money goes into putting a transaction deal together, and, if the deal were to fall through, you would have lost all that time. Perhaps, there was an opportunity for another deal that you passed up.
- IT security
- Legal implications
- Cultural mismatch
The risks of a cultural mismatch could lead to significant issues with overall company integration among several departments. The term "synergy" is often used by buyers, but often those synergies don't materialize if the risk is not mitigated first.
How to Mitigate These Risks on the Seller-Side
On the sell-side, mitigating M&A transaction risk is all about preparation and being ready to go through with the deal process.
Many entrepreneurs and business owners are busy running and operating their businesses, and what they often don't take the time to do is prepare their exit strategy ‒ until they truly need to exit.
The more time and effort that can be put toward an exit strategy upfront, the better. At a minimum, business owners should give themselves a five-year lead time to finalize their exit plan.
Proper Financials and Good Bookkeeping
Before selling your business, it's imperative to get your financials in good order. Be sure to clean up your accounting so that a potential reader can be a confident buyer and trust your numbers.
Small business owners, especially, run dubious business expenses through the general ledger, often muddying the difference between personal and genuine business expenses. While we understand the reason for this method, if you want to best position yourself to sell the business, your records need to be clean. There should be solid segregation between what is personal and what is being sold to the buyer.
If you own multiple companies, you will want to avoid any unnecessary intercompany mingling of assets and transactions among your financials. Again, be sure there is a solid breakout of what is actually being sold, versus activities that are unrelated.
Proper Tax Planning and Performing a Business Valuation
For small business owners, a large portion of their wealth and assets is their business. So, before selling your company, you need to ask yourself these important questions:
- What kind of payout do I need in order to comfortably live the lifestyle I want?
- Will I sell my business, but continue to work for a number of years?
- Can I sell and exit at the same time?
Understand what the current valuation of your company is. If you don't know the value of your company, a valuation done by a Certified Valuation Analyst (CVA) and/or an Accredited in Business Valuation (ABV) professional should be performed.
Having a valuation done also helps to take some of the emotion out of the transaction.
Selling your business can be a very emotional decision for business owners. Still, the more you can take the emotion out of the financial component, the less likely you will be to ruin what could potentially be a good deal.
Proper Due Diligence
As you are getting ready to sell your business, you should also be looking at having some diligence done on your business because your potential buyers will definitely be doing their due diligence.
The more you can prepare for the questions your buyers will ask, as well as identify any issues upfront, the better.
This may mean going through a full financial Q of E (Quality of Earnings) upfront or a deep dive into earnings before interest, taxes, depreciation and amortization (EBITDA) and working capital so that you understand precisely where any pitfalls may lie.
Many businesses rely on their existing accountants to perform this sell-side due diligence, which is not uncommon, but having work done by a third-party firm may be able to provide valuable new perspectives.
How to Mitigate These Risks on the Buyer-Side
The best way to mitigate M&A transaction risk is to be sure you put the right team of professionals together among all departments ‒ accounting, tax planning, advisory, legal, human resources (HR), and IT.
Hire the Proper Team of Professionals
One of the biggest mistakes we see on the buy-side of the transaction is business owners trying to do their own buy-side due diligence ‒ as if a business owner didn't have multiple jobs already. Trying to cut costs by not hiring quality advisors will most likely result in a dragged-out transaction and increase the likelihood that the transaction will not close.
In another situation, the business owner may rely on their Controller or CFO level personnel, who may or may not have experience in mergers and acquisitions, whether they went through them or were involved somehow on one side or the other of the deal.
The responsibility of handling an M&A transaction often asks a lot of your personnel and increases your risk to the transaction.
Beyond financial and tax, you should be sure you have the right people in place to look at the IT security of the company you are buying, the current benefits [401(k), healthcare, etc.] and any potential legal aspects of the company.
Could there be any litigation that you are not aware of? Who you hire on the legal side, especially, is crucial to the success of the deal. It's recommended that you don't use the same attorney for a transaction that you would typically use to represent your company or even yourself on a day-to-day basis. You should hire an attorney who is an M&A specialist.
Find someone who understands how to navigate these types of transactions, where the negotiations begin and end, and where the pitfalls lie.
In addition, hiring your legal team up front in the deal will be helpful. Many transactions are predetermined. But it's important to understand how the letter of intent is written. If you don't hire your attorney early in the process, you may find difficulty when it comes time to write the stock purchase agreement or the asset purchase agreement.
Don’t Skip Out on Tax Diligence
If you go through your financial diligence but pass on the tax diligence, there is a lot of potential exposure on the tax side, even if you think you've structured it correctly and have the right representations and warranties in place.
For example, if you're planning to purchase the stock of a company, you will want to take a close look at that.
There's still a lot of goodwill in these deals today and buying the assets or selling the assets of the company can be beneficial to both parties and reduce the amount of long-term risk as well.
In general, there can be many issues regarding tax liabilities and jurisdictions, especially with international companies, so it's best to have an open mind and do your tax diligence.
For business owners considering going through an M&A transaction, it’s important to hire the right professionals and advisors, determine the right value, have a good letter of intent, and make sure that the transaction fits into your overall strategic plan not just for the company(ies), but also for yourself.
For more information or assistance with your current transaction activity, contact your PKF Advisory team member or:
Brian P. Sullivan, CPA
Drent J. Shields, CPA, MBA, CISA, CITP