Mergers and Acquisitions For Dummies (47 page)
Read Mergers and Acquisitions For Dummies Online
Authors: Bill Snow
Info about competitors
The offering document should also include information on Seller's competitors. Seller needs to demonstrate to Buyer that it understands the competitive landscape. Additionally, this information may help a Buyer who's new to Seller's specific industry get an overview of the main competitors and assess the competitive risks.
In addition to listing competitors, the offering document should provide some insight into each competitor's relative strengths and weaknesses, revenue size, and percentage stake (roughly) of the market.
Note:
If one of the listed competitors is also reviewing the offering document, that competitor instinctively goes to the competitor section and corrects, contradicts, or otherwise chuckles about whatever the entry says. No matter what Seller writes, the competitor will take some sort of umbrage with it. Wouldn't you?
Doing the Numbers
Numbers don't necessarily speak for themselves, and Buyers don't want to have to translate them, so you as Seller should take care to present your financials in the offering document in the best light possible, as the following sections demonstrate.
You can't get around dealing with accounting and financials in the offering document, so make sure whoever is compiling this part of the offering document has strong accounting skills.
Historical financials
I recommend an offering document have at least three years of historical financial results; five years is much better.
An offering document with three to five years of financial results helps Buyer better understand the recent trends of the business. Some of the key historical financial aspects include
Are sales increasing or decreasing? What about profits?
Is the company maintaining its gross margin?
Are any operating expenses getting out of control?
How much working capital does the company have?
Does the company collect accounts receivable in a timely fashion and pay its bills on time?
Does the company have long-term debt, and will that debt get in the way of doing a deal?
Make sure you include a full set of financials: income statement, balance sheet, and cash flow statement.
When presenting financials, present the numbers down to an EBITDA calculation. If the company has substantial
add backs
(nonrecurring, one-time only, or owner-related expenses), include those add backs in the historical and current financials. Make sure you provide details of what exactly those add backs comprise.
The add back machine: What's legit and what's not
An
add back,
for the uninitiated, is an expense that is added back to the profits (most often EBITDA) of the business for the express purpose of improving the profit situation of the company. It's a bit of alchemy; when you toss in enough add backs to the profits of a company, you turn EBITDA into the mythical “adjusted EBITDA.”
The theory behind these add backs is that these expenses are purported to be extraneous, one-time, and/or “owner's” expenses. In plain English, these add back expenses will either go away once the company is in the hands of the new owner or won't be incurred again.
Some legitimate add backs include the following:
Adjustments to owner's compensation:
Many owners of closely held companies, especially successful and highly profitable ones, give themselves outsized salaries and bonuses. Nothing is wrong with that, of course, but an acquirer is unlikely to pay that kind of compensation to the new president (and other execs). For example, if a reasonable salary for the president of a certain-sized company is $150,000 but the owner of such a company paid herself $500,000, a legitimate add back would be $350,000. This add back means EBITDA would improve by $350,000, thus improving the potential valuation for Seller and providing a roadmap of greater profitability for Buyer.
Taxes and benefits:
If making add backs for adjustments to owner's compensation, make sure to add back the corresponding taxes, too. If an owner and/or other employees are leaving the company post-acquisition, the benefits these people were paid may be appropriate add backs, too. The main benefit for most owners is insurance. If the owner won't be replaced, the full amount of insurance can be added back; if the owner will be replaced, the replacement insurance package may not have all the bells and whistles of Seller's plan.
Severance and lawsuit settlements:
Severance payments and lawsuit settlements may be cause for further due diligence on behalf of Buyer, but these payments can be another example of a legitimate add back, assuming these sorts of payments are truly rare and unusual for the company.
Personal expenses:
Running personal expenses through the company is a common occurrence in closely held companies. These companies often practice the so-called Family Accepted Accounting Principles, or FAAP (to use some slang), in addition to (or in replacement of) Generally Accepted Accounting Principles (GAAP). If an acquired company does utilize FAAP, these personal expenses are a legitimate add back because the new owner won't continue to incur these expenses.
Note:
FAAP is firmly a gray area for taxation, so speak with your accountant as to the proper treatment of these expenses.
Disclaimer:
Mergers & Acquisitions For Dummies
doesn't suggest owners should engage in FAAP. Instead, the author realizes these expenses are often included in a closely held business's income statement.
Personal expenses may include the following:
The clubs (hunting, country, health, and so on)
Owner's car expenses (monthly payment, insurance, gas, and so on)
Family members on the payroll
Travel, meals, entertainment for personal use, not business purposes
Any other expense that is personal in nature and not a business-related expense
So, what add backs aren't legit? This group is a little more difficult to quantify because types of expenses are virtually limitless. Instead, apply a simple two-part rule of thumb:
If one-time-only expenses show up on a company's income statement year after year, they aren't one time; they're recurring and therefore not a legitimate add back expense.
If the company will incur add back expenses post-acquisition, they aren't legitimate add backs.