In the world of psychology, there’s a phenomenon called “first-instinct fallacy” that maintains we tend to trust our initial gut reaction to something, even when we shouldn’t. So maybe while that impulse reaction to, say, an investment opportunity may be helpful in saving us from ourselves (and bankruptcy), the world of mergers and acquisitions (M&A) relies less on instinct, using years and years of experience with due diligence.
As such, it’s not surprising that some of the industry’s biggest M&A players are adept at spotting a cause for concern in the due diligence process that either prompts deeper vetting or, at the far end of the spectrum, brings the talks to a screeching halt. Some of the red flags are more prominent, others may be far more subtle. As part of the April State of the Industry report on M&A, we’ve asked our panel of dealer execs to share the warning signs that may be worth heeding during the courtship process between buyer and seller.
One of the more frequent issues is when inventory assets are misclassified or aged past their useful life, notes Eric McIntosh, senior vice president, WiZiX Technology Group. This can significantly skew the final sale price.
Another cause for concern is how owners account for commissions they would have earned on deals they close without taking a commission. “Often, they let this boost the bottom line without reflecting it in sales expenses, which distorts the EBITDA we can realistically achieve post-acquisition,” McIntosh said. “And a lot of sellers fail to realize the impact of their prepaid maintenance agreements, since it’s calculated as a liability against the sale price.”
Travis Sheffield, vice president of acquisitions for UBEO Business Services in Austin, Texas, notes that there are few surprises during their due diligence process. The more common issues, such as accounting or contractual irregularities, are generally ferreted out in early discussions. The real deal-breakers generally are not cloaked or obscured.
“Challenges can arise if there is a sudden decline in financial performance or the loss of key customers before closing,” he said.
The lack of tracking for old inventory often indicates operational inefficiencies that can create issues post-acquisition, notes Jim Haney, CMO for Doceo of York, Pennsylvania. Another indication of a potential problem is OEM instability.
“Dealerships with inconsistent or problematic OEM relationships raise concerns about future product availability and serviceability,” Haney noted.
Jason Weiss, executive vice president and legal officer for Atlantic Tomorrow’s Office of New York City, points to problematic data that has cannot be reconciled. That data can often be incomplete or inaccurate.
“One example is financial data that doesn’t tie to previously provided financial information or across financial statements,” Weiss noted. “Other red flags can include a lack of transparency and/or misrepresentations. Significant changes to the organization chart in the periods leading up the transaction [is another cause for concern].”
