Business Consulting specializing in professionally confidential targeted mergers and acquisitions in the small to mid-market range; exclusively in the Drug Testing/Employment Screening/Urgent Care and Occupational Health Industry.

Why Use a Consultant?

Negotiation skills are paramount for a consultant.

Why use independent consultants in the acquisition/sale process?

  • To perform acquisition scans, pre-acquisition/sale due diligence, or help in post integration.
  • To engage in dialog with the market(s) served and competitor(s) in order to adequately check assumptions, competitive landscape, market dynamics, and perceptions of competitors regarding the acquiring and selling company, and other companies under consideration, without the risk of bias.
  • To benefit from another experienced look and opinion.
  • To augment your own internal resources.
  • To speed the process.
  • Sometimes it seems that M & A stands for “media and aggravation”!

Adding a new property to an organization, or combining two organizations, is a strenuous legal and operational challenge. The added employees must become part of an existing corporate culture, or a new culture must evolve for the evolved entity.

It is an advantage, and a potential bottom-line enhancement, if duplication can be eliminated and efficiency improved. However, that usually means that people will lose their jobs, creating anxiety and often resentment among the employees who survive. Entire offices may be closed, creating job loss and/or need for relocation.

Every organization has its formal policies, and unwritten idiosyncrasies and ways of doing things that have evolved informally. Decisions must be made about which of these policies and customs will be retained in the new environment, and which will be eliminated or modified. Then a new internal communications effort is required, to bring the employees up to speed on the changes.

There’s always a reason why one company is a target vulnerable to acquisition, or voluntarily seeks a merger of equals. One part of due diligence is understanding the factors that made the business vulnerable or subject to improvement, and making sure that the surviving entity will be able to overcome the predecessor's problems and be successful and profitable.

A great deal of the work involved in due diligence will be done by the staff of the acquiring company or two merger partners. Professional advisors such as the attorneys, accountants, and actuaries for benefit plans have important contributions to make. However, retention of an independent M & A consultant should also be considered--a seasoned professional who has already consulted in conjunction with other transactions.

Consultants serve as an unbiased resource in testing the assumptions, (financial, market related, and competitive), that propose to support the acquisition or merger. One type of consultant to consider is the independent M& A consultant who goes beyond the numbers to investigate the underlying national market and regional market, while keeping the identity of the seller and buyer confidential.

A consultant is able to check financial projections and general assumptions with market dynamics and reality.

LEGAL REQUIREMENTS FOR DUE DILIGENCE

“Due diligence” is a concept from corporate law. A corporation’s Board of Directors has the ultimate legal responsibility for managing the company, on behalf of its stockholders. The directors are “fiduciaries”--they are responsible for other peoples’ money. The legal system is very strict about the responsibilities fiduciaries have to their constituencies. Before they enter into a major transaction such as buying another company or another company’s assets, merging with another company, issuing new kinds of stock, entering into major borrowing transactions, etc., the directors must engage in “due diligence.” That is, they must do a complete, thorough, and objective examination of the potential transaction (The use of Independent consultants may enhance and speed this process.).

First of all, they must determine the accuracy of the information provided by the other party to the potential transaction (e.g., the company’s assets, liabilities, and profit picture). This information must be used to make projections about the advantages and disadvantages of the deal as proposed. The inquiry also identifies problem areas that could make the proposed deal illegal, more expensive than anticipated (e.g., if loans have to be paid off ahead of schedule because of the transaction), or simply a poor value.

Usually, the surviving company, or the merged company, will need a single compensation and benefit structure to replace what may have been a patchwork of systems resulting from corporate decisions as well as earlier acquisitions and divestitures.

It will also need to create a new corporate culture that combines the best elements of preceding cultures and adapts them to the current environment and larger business environment. Nearly always, the transaction will be based on written documents. Each party will make representations and warranties (disclosures and promises). It’s easy to think of these lengthy documents as trivial and boring legal boilerplate--but the temptation should be resisted, because very subtle differences in wording can have tremendous practical and economic consequences after the transaction goes through.

LEGAL RISKS AND OBSTACLES

The due diligence process should also uncover existing transactions that may prevent or cause restructuring of the contemplated transaction. For instance, the target’s mortgages, commercial leases, and business loan agreements may make large balances due and payable whenever control of the business changes. Having to come up with large sums of cash can be inconvenient or even worse for the acquirer. Either as a retention tool or as a deterrent to unwanted takeovers, some companies provide their top management with “golden parachutes”--i.e., entitlement to very large severance payments.

These will have to be taken into account in calculating the financial consequences of the transaction, and may also influence which employees will be asked to remain with the surviving organization.

Furthermore, if there will be a reduction in work force after the transaction, the new management should be very careful to document that candidates are chosen for termination based on legitimate factors such as duplication of jobs and performance. This will help rebut charges that an undue number of women, older employees, or minority-group members were terminated. It’s also a good idea when negotiating a severance package to have the terminated employee sign a waiver stating that he or she will not sue for discrimination or wrongful termination. Any waiver must be carefully drafted by an experienced attorney who is up-to-date on the law of waivers.

BUYER’S AND SELLER’S EYE VIEW

Most of the attention is on the buyer’s take on the due diligence process. After all, the buyer will be making a major expenditure (in cash, stock, options, assumption of debt, and other payment forms) and has a practical as well as legal obligation to make sure that it is not buying a “pig in a poke”. However, because the due diligence process starts very late in the history of a transaction, it really merely confirms the information that the buyer already has, and assures the buyer that it will obtain the intended consequences from a transaction.

It is an abuse of the process (and one that is likely to backfire!) to use the due diligence stage to raise real or purported objections in order to cut the price already agreed upon. However, the seller also has responsibilities to its shareholders, and also has the practical task of making sure that the buyer’s representations and warranties in the deal’s documents are accurate. This is especially crucial when the seller will be receiving stock, stock options, and/or corporate debt, instead of, or in addition to, cash. A value has to be placed on these securities at the time of the deal, and their future value will help determine whether the deal was a fair one and whether it was a success for both parties.

SPECIAL FEATURES OF SERVICE COMPANIES

Customers who buy flour, or chemicals, or fabrics will be satisfied as long as the quality of goods remains stable or improves after an acquisition, as long as price increases are tolerable, and as long as customer service does not deteriorate. After all, these commodities have no personality. However, a drug testing/employee screening/urgent care & occ health/urgent care company is a very different thing. Its clients either turn to the company as a unique source of necessary business information, or because it offers a better mix of services, other products and services not available with competitors, or simply because of geographic or service related issues. These client preferences are what make the company attractive to its clients, which is crucial in the business to business market.

Some reasons why service organizations, like drug testing/employee screening/urgent care & occ health companies merge or acquire other companies:

  • The local/regional market will support one well-funded, high-quality company, but not two or more low-budget poor service competitors, so collaboration makes it possible for the more ambitious company to survive.
  • Each company has complementary strengths: one may have award-winning service, the other geographical coverage; one may be extremely user friendly, while the other has exceptional industry niche marketing.
  • One organization may have a great track record running trade shows and conferences--ancillary events that wise business creators are using to leverage their audiences and achieve additional profits.

To an increasing extent, clients are seeking to align with companies that have successfully implemented the Web as a client interaction tool (sometimes stand-alone, but usually to supplement one or more business lines). For each company to be acquired, it is vital for the acquirer to have complete, accurate (and, where applicable, audited) financial information. The transition is also a chance to communicate with existing clients. Let them know how the company will change, and how the rate structure will change (if at all) after existing contracts expire. Also, it’s a time to go after potential new clients who may have been discouraged by the operations of the previous management.

Changes can also be implemented in production methods and relationships with vendors and service agents. It may be possible to outsource work now done in-house, or vice versa. However, any change depends not only on a prediction that is financially sound, but on legal review of business contracts and collective bargaining agreements (if any).

INTANGIBLE ASSET

In the 19th and early 20th centuries, a company’s assets consisted of cash and tangibles such as real estate, manufacturing equipment, and inventory. Today, we recognize that intangible things, such as brand equity and the loyalty and creativity of the workforce, are assets critical to success. Furthermore, all companies are beginning to understand the value of intellectual property assets.

For some companies, this will mean patents; for others, trade secrets and customer lists; yet another option is reputation, brand equity, and national or international reputation. However, for service companies, the leading assets are apt to be loyal clients (especially with good survivable contracts), a sophisticated IT platform and geographic and industry positioning. The acquirer must investigate the state of these assets to verify their value.

Repackaging assets can be a strong revenue generator--a tactic pioneered by movie studios that re-release their old films, license clips for advertising or promotional use and use in compilations, develop line extensions such as video games, and make sure that old products are re-issued in DVD and other new formats as they emerge. However, repackaging of assets in the service sector can be just as important and create a new or stronger revenue stream.

A merger or acquisition can be a way for the new organization to take a creative look at existing lines of business. Perhaps anthologies can be created of past business lines that have not succeeded (why didn’t they succeed). A common tactic is to combine two or more business lines of the two merging organizations, to save money and maximize the use of assets, thereby improving profit figures. Or perhaps movement should occur in the opposite direction: developing a new product as a line extension to leverage the value of the existing client base.

There is increasing understanding throughout the economy that managing “electronic assets” is vital to commercial success. Of course, this is especially true of drug testing/employee screening/urgent care & occ health companies. All assets, including “electronic” need to be managed creatively!

FINANCIAL DUE DILIGENCE

A potential merger partner or acquirer will have to get a complete, detailed, and accurate picture of the finances of the other company, which in turn will have to be able to explain its entire financial history and current status. The would-be acquirer must understand the potential acquisition’s corporate structure (its subsidiaries and affiliates) as well as less structural business arrangements such as joint ventures and strategic alliances.

The following corporate financial documents will have to be prepared, audited, disclosed, and reviewed, generally going back for a three-year period:

  • Balance sheet.
  • Income and cash flow statements.
  • Historical data, including audited financial statements (if available), with the auditor's notes and management letters.
  • Disclosure of any changes in auditing firm, accounting practices, or accounting methods.
  • Disclosure of any ongoing or anticipated lawsuits (as defendant or plaintiff).
  • Disclosure of liabilities incurred outside the ordinary course of business.
  • The target’s dividend history.
  • Description and appraisal of the target’s real property and personal property assets (e.g., business equipment; fixtures; computer systems; office equipment).
  • Explanation of loans.
  • Explanation of any dispositions of assets--especially intellectual property assets-outside the ordinary course of business.
  • Federal and state income, franchise, and sales tax returns.
  • Financial and operating plans going forward (e.g., for two years), including forecasts for the target’s cash flow, income, and balance sheets.

An important question is the integrity of the items on the financial statement. There may be deliberate or inadvertent violations of accounting standards and the target may give itself the benefit of the doubt when it comes to close questions. The cash on hand may not reflect the accurate picture, if the target has deferred paying expenses that will have to be paid by the acquirer after consummation of the transaction.

The financial statement can also be given an artificial appearance of health through the utilization of non-recurring items (e.g., special issues and one-time discounts) and treating barter transactions as if they involved cash. Such exploitation of barter is especially common in the financial accounting of Web sites, which typically trade advertising with other sites, with each site reporting the transaction as if they had received the revenue in cash.

BUSINESS STRATEGIES FOR SURVIVAL

The engagement of independent consultants may add value and speed the analysis as outlined below :

  • Market analysis: forecasts for the relevant market after the transaction.
  • Competitive analysis: how the surviving entity will do against its competition; its status within the market.
  • Growth analysis: what are the sources of the target’s growth in the last few years? Can those trends be sustained?
  • Analysis of leading indicators.
  • HR analysis: which top managers, mid level managers, and rank-and-file employees from the acquired organization will be retained?
  • Will the pricing to clients “hold the line” or increase after the transition?
  • What will be the response of clients, vendors, employees?
  • How will joint ventures be affected?
  • How will the transition affect the Web presence? Will additional URLs have to be reserved?
  • What will the new organization’s privacy policies be and are these policies adequate?

Although there are mergers between equals, it is perhaps more common for the transaction to have been motivated by some type of weakness in the target, e.g., a need for more capital, a need for a more robust IT platform, a need to move into another geographic or industry specific area, a need, on the part of the entrepreneur owner to retire.

Sometimes in order to “groom” the target’s financials to make the target more attractive to potential buyers or to increase the sale price, some compromises in quality have been made. For instance, staffs may have been reduced; service quality might have declined; cost of goods spending might have been reduced. An increase in the number of clients, tests or products (like on-site testing devices) can be a positive sign (Especially if it stems from high-quality customer service that will attract and keep loyal clients!) but can also be a purely cosmetic device to make the selling company look healthier.

HR DUE DILIGENCE

One of the key concepts of human resources review in the M& A context is that federal law prevents employers from eliminating or reducing benefits that have already been accrued by employees. However, the general rule is that--as long as the legal documents of a pension or benefit plan reserve the employer’s right to modify the plan--changes can lawfully be made going forward.

It is suggested that companies considering an M& A transaction should make a chart summarizing the benefits design of the two combining companies and the survivor organization. The categories suggested are medical benefits, dental, vision, life insurance, disability insurance, vacation, and sick leave. Side-by-side comparison should be made of features such as type of plan, employee co-payment responsibilities, and extent of coverage. With this information in hand, the management team will be able to make accurate cost projections and see what percentage of total salary each benefit represents.

HR due diligence issues include:

  • The targets payroll practices and history, including compensation (not just salary, but also bonuses, profit-sharing, and stock options) paid to top management and/or major stockholders.
  • What benefits will have to be provided in the future?
  • Policies, stock options, and other forms of incentive compensation.
  • Policies for using full-time permanent workers versus contracting out and using independent contractors, temporary or part-time workers.
  • What insurance coverage must be secured and maintained (and by whom)?
  • Whether separate accounts will have to set up and funded in advance to secure the payment of benefits, or whether the successor organization can follow a “pay as you go” policy.
  • Which employees are entitled to notices (for instance, about their right to continuation coverage and options for getting pension payouts) and who will provide the notices. Federal law permits the imposition of heavy civil fines and penalties on companies that fail to provide these notices--over and above any legal liability to workers who did not receive required notices.
  • The proper accounting treatment for pension and welfare benefits.
  • Whether federal agencies such as the IRS and the Pension Benefits Guaranty Corp. (PBGC) are entitled to be notified of the transaction; if they have veto power, or if their consent must be obtained for the whole transaction or for accounting or actuarial decisions taken in conjunction with the transaction.
  • Disclosure, reporting, and funding of vested benefits that have already been earned by employees in the past and cannot be altered in the future.
  • Communicating the new benefits package to employees; this is not only a difficult public relations challenge, but is subject to detailed federal rules which must be obeyed.
  • How payments and reserves will affect the successor organization’s bottom line when quarterly earnings must be disclosed (assuming a publicly traded company)--and how this, in turn, will affect the stock price.
  • Whether it is likely that employees that the surviving organization wants to retain will stay on or leave (because of compensation policies or other factors).

Steps to be taken to ensure--and document--that layoffs and Reductions in Force are not done in a manner that discriminates against any protected group (minorities, women, persons over 40). How laid-off and fired employees will be notified; severance policies; corporate policies for obtaining legally valid waivers preventing employees from suing the survivor organization after their termination

CAPITAL MARKET CONSIDERATIONS

Many transactions occur between two companies; one or both that are already public. In that case, it is crucial to estimate how the transaction will be received by the capital markets. One very important measure is the effect on stock prices. All too often, the announcement of a pending merger results in reduced prices for both companies! It is also important to consider the opportunities for borrowing money or making secondary offerings of stock; if the capital markets are unresponsive, then funds for operations, marketing, and expansion will be available only on unfavorable terms, or not available at all, leading to a need to cut costs and defer upgrades and expansion into new markets. However, if at least one partner is extremely prosperous, then it will be able to use its cash to fund expansion without seeking new borrowing or secondary stock offerings, or will be able to use its own stock as currency in order to make further acquisitions.

COMBINING CORPORATE CULTURES

One of the biggest challenges is welding two organizations, each with its own traditions, ways of doing things, and atmospheres, into a new organization that can achieve even greater success. It can be very hard for middle-aged suit-and-tie managers to work with counterparts who are not only much younger but have different beliefs about work dress, etiquette, and how to collaborate (via face-to-face meetings with paper minutes? by cell phone and e-mail?). The managers of the surviving organization need a vision of what the new company will be like--and also need steps for getting there, by understanding and managing employee expectations.

Wherever possible, employee input should be solicited--and really used in the decision-making process, not just asked and ignored!

The computer networks of the two organizations must also be combined, or replaced with a new network. But before this is done, issues of compatibility, ability to transfer existing files to the new system, cost of implementing the new system, risks of downtime and lost data, and need to train personnel to use the new system must all be considered.

The two organizations must also be able to combine their work-flows, and must harmonize their policies about dividing work between staffers and independent contractors. It may be necessary to adjust budgets (and benefit projections) based on a shift to or away from in-house work. Increasing the role of independent contractors adds flexibility, permits cutbacks without loss of full-time employees, and reduces the benefits budget--but adds an element of uncertainty and requires additional supervision.

WHY SOME MERGERS & ACQUISITIONS FAIL

Nearly half of all service industry executives expect their businesses will enter a merger in the next three years, according to a Grant Thornton Business Owners Council Survey. The survey also reveals that poor integration strategies, the loss of key personnel and lack of compelling strategic rationale are the major reasons mergers and acquisitions fail (up to 72% according to some projections). Failure can be attributed to:

  • Poor integration strategies: 65%
  • Key employees leaving: 62%
  • Lack of compelling strategic rationale: 61%
  • Acquiring company did not do sufficient due diligence: 60%
  • Poor internal or external communications: 59%
  • Corporate culture clashes: 55%
  • Premium paid for the company was too high: 53%
  • Unrealistic expectations of possible synergies: 52%

SUMMARY

A successful merger or acquisition displays synergy: the new organization is more efficient, has greater marketing and other revenue sources, serves its clients better, and uses its assets more fully and creatively than the predecessors. This is a difficult task, of course, and requires detailed, intelligent planning. The due diligence process can be the means to gather the information that impels the next stage of success.