In conjunction with this month’s state of the industry focus on mergers and acquisitions, we’d like to provide you with a look at the various stumbling blocks that can either stall or completely stymie a deal before the final contract is signed.
Often times, the obvious sticking point in any deal is agreeing on a valuation for a perspective acquisition. There are many factors that can determine whether a company should fetch in the 2X range of EBITDA, the 7X high end or in-between (most of our panel placed the typical value in the 3-6X range). Obviously, that span represents millions of dollars and a lifetime of blood, sweat and tears invested, so where that final valuation lands is a major point of contention. But not the only one.
“Some dealers will have a very large customer that may skew their business a lot,” noted Jeff Gau, CEO of Marco. “An MPS deal could be a large copier customer. Depending on where they’re at in the contract, that’s an element of risk.”
Stale Goods
Inventories can be another cause for concern, according to Gau, particularly if they have sat for a year or more. A dealer would look upon older inventory differently than a local bank, and Gau (for one) is skeptical about whether older material on hand will actually ever be consumed.
Another element that can make an acquiring dealer take pause is if the prospective acquisition is coming off its best year by far. “It doesn’t have to be a red flag, but it’s a flag,” Gau said. “So we’ve got to validate how that’s going to be sustained. It’s one thing to get to a certain level, but how are you going to keep it there?
“Sometimes, with the addbacks to EDITDA, the dealers will say they invested a lot to get their managed IT practice going, and it really didn’t work out. Well, that might not be considered an addback because it’s still there, they still have the managed IT business, and they want us to pay for it.”
Chip Crunk, president and CEO of RJ Young, notes that sellers fall primarily into three categories: those who are having cash issues, partner issues or are looking for an exit strategy. Each one, he adds, present unique dynamics that call for a tailored approach.
It is easy to determine when a deal is going to fall apart, and that’s generally at the onset of discovery. “Being in the industry a long time like we have, I kind of know who the quality players are and who the shaky ones are. It’s important to know the ones to be really cautious about as you’re going through the process.”
The model is different for those companies like Flex Technology Group, where the owner is staying aboard and reinvesting in the collective company. Dan Ruhl, a principal with Oval Partners, notes that given the different mindset in the approach, not all prospective additions to the group will have a strong sense of what their business may be worth. Thus, when the offer is made and the value doesn’t work for the business owner, that is generally the biggest sticking point.
“If we work through all of the other issues with the business owner, we’re normally getting to the finish line,” Ruhl noted.
Due Diligence
Getting financials to pass the due diligence process is generally the area where most deals fall apart, says Dan Cooper, president and CEO of Novatech. By the same token, a red flag doesn’t automatically mean a transaction will not reach the checkered flag.
“Most stumbling blocks do not have to derail the deal; they will just set the train on a longer path until close,” he remarked.
That is where experience and tactical patience comes into play. Jim Sheffield, president and CEO of UBEO Business Services, notes that sellers can become impatient with a due diligence process that is lengthy and in-depth. But buyers owe it to themselves, and the seller, to make sure the numbers are fully vetted.
“When you’re paying good money for an asset, you’re going to want to look at it thoroughly,” Sheffield added. “If (sellers) don’t understand that and get frustrated, that’s probably something that can get in the way of these deals.”
