Warning Signs on the Road to M&A

Updated: Oct 9, 2019


Warning Signs on the Road to M&A


There seems to be a startling new trend of senior management teams, including founders and CEOs, who sign contracts and documents that they’ve never completely read, or at the least never fully understood.


All too common example? Loan agreements, even standard bank loans and lines of credit, with common covenants that must be complied with to avoid a technical default and damage to the company’s credit rating. Extremely often we find that the company’s banker is acting as the de-facto Controller of the company. Not at all healthy because by the time the banker has (or disturbingly has not yet) received the financial metrics the company is already out-of-compliance i.e. “in trouble”.


There continues to be a wide availability of credit and other funding…for the businesses that have their house in order. Not for everyone. There is a very common logical fallacy that because banks, other lenders, and private equity funds have record amounts of “dry powder” that they are just giving money away. Not the case, not at all.


Well managed companies are getting the credit and the funding they need at the best rates ever, companies with weak or poor accounting are not. If lucky they are getting some credit but paying more for it than anyone else, and with the most restrictions. Additionally, they are not getting it quickly which implies a very expensive opportunity cost, especially when their competitors are ahead of them and getting the money they need to expand and grow.


Also many are just not able to take advantage of opportunities quickly, and as we have seen this year and last year for those sourcing from China, not being able to react nimbly and quickly leaves them stumbling & fumbling in uncoordinated attempts to maintain their sales volumes and profit margins, and prevents them from planning and budgeting well for 2020.

Founders, CEOs, and executive management more and more often need an independent experienced third-party advisor to challenge them on key assumptions and to push-back when and where underlying business and market logic has changed. Board members need this same expertise to aid them in their evaluations of the business strategy.


Innovative solutions require not doing more of the same, nor automating the way it has always been done, but evaluating what still works great and what is no longer cutting it. And innovative is not always, and almost never only, a technology solution.


Why does so much M&A fail? Why do so many ERP solution implementations fail? For the same reasons: lack of deep, complete evaluation and understanding of the elements and drivers at a fundamental operational level; unfortunately, quite often there is a deliberate ignorance of these key drivers by “focusing” only on a top-down approach.

In plain English, egos not being checked at the door, which combined with an over-reliance on numbers…. but the wrong numbers, leads to inadequate management of expectations and over-promising. Specifically, valuations and cash flow forecasts that are way off and not realistic at all. Often by extremely intelligent people…whose emotional intelligence has not caught up with their brilliance in their area of Subject Matter Expertise.


Expensive failures, and many dramatic train wrecks, caused in large part by ignorance of the soft attributes of the business in question and a deliberate minimizing of key operational and financial data before truly ascertaining if it is valuable or not.


It’s impressive how many fantastic entrepreneurs and successful businesses can become large middle market companies with practically no financial management other than the traditional checkbook look…. until their business stalls like a jet out of fuel…and the ground starts coming up really quickly. And they don’t all pull up in time. This year alone we have seen M&A transactions torpedoed and fund-raising efforts fail because of accounting “records” that looked like a kindergarten student prepared them. Founders and entrepreneurs are not expected to be CPAs nor MBAs. But they are expected to hire them. Reasonable and accurate financial statements are a must, basic business management. Not a luxury, not a necessary evil. Just one of the most basic tools for managing a business. And for not overpaying your taxes as well as a host of other benefits.


You get what you pay for. A CPA costs more than a junior accountant who costs more than a bookkeeper for a reason. And a growing company may need all of them. The longer a deal takes to get done the greater the chance the deal dies. Many deals with solid business fundamentals are delayed and often derailed due to inadequate accounting. Accounting which does not reflect the actual operations will delay the deal indefinitely. No one lends or invests millions of dollars against poorly prepared financials. They just go look for another deal. If the accounting firm is charging you less than your cell phone bill how much expertise and care do you really think you’re getting? Too many business owners are kidding themselves thinking they’ve gotten a bargain yet are waiting months to get their accounting close done and then receive limited and incomplete reporting. There are plenty of good, quality, accounting and bookkeeping firms. They will be affordable, but they will not be dirt cheap. Talk to 2 or 3 then choose the one that communicates best.


These companies also often face uncertain situations where a permanent position (M&A Director, CFO, COO) is not yet defined or not the right decision at this point in the growth cycle. Strategic short-term talent or outside leadership advisory also often makes a lot of sense when it is event driven, i.e. when the leaders are focusing on urgent, unexpected projects or unbalanced workloads, and should be taken advantage of as they often more than pay for themselves. Additionally they send an important signal that the shareholders are serious about doing a good deal and have the fundamental professional help to manage the process with private equity and others from the investment community.


Best regards,

Andrew

Middle Market Advisory LLC

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Dallas, TX 75240

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