Industry Insights

Diligence Required to Improve Company Value

March 2012
Author:  John Mather

John Mather

Partner

Audit

Manufacturing & Distribution

One Metropolitan Square
211 N. Broadway Suite 600
St. Louis, MO 63102-2733

St. Louis
314.231.5544

Recovery continues to be slower than most businesses would prefer. Part of the slow growth is due to pessimism from many business owners on whether they can trust some of the leading economic indicators released in the past few months.

On a positive note, recent trends have shown that unemployment is being reduced overall. The National Association of Manufacturers also reported that more than 31,000 new U.S. manufacturing jobs were created in February. This increase, however, is tempered with the belief that many unemployed individuals have simply given up on job searches, as they have now been out of work for an extended period. Their drop from the search effort causes many to fall off of the tracked statistics. This may be causing some lower-than-actual unemployment numbers to be reported. In addition, a recent University of Michigan study showed consumer confidence figures have fallen slightly due to weakening perceptions about the economic environment.

Two other areas facing business owners have caused them to move at a slower pace when considering expansion, acquisitions and hiring of additional employees. These two areas are taxes and looming health care changes. With the potential for higher taxes and higher health care costs on the horizon, many entrepreneurs are taking a wait-and-see approach. Thus, the reports of companies continuing to pay down third-party debt and stockpile cash still exist.

It seems businesses have returned to profitability as a result of concentrated efforts aimed at enduring the economic downturn. The threat of losses, liquidity issues and, in some cases, covenant violations forced many businesses to lean up operations and challenge spending. As a result, many are doing more with fewer resources and have improved processes. Earnings levels have improved, but most results are still below the levels experienced in the mid-2000s.

Also on the periphery of concerns is uncertainty in foreign markets. While we have had a credit and debt crisis here, overseas trouble has many business owners contemplating international business relationships and opportunities. In the mid-2000s, many production jobs were moved overseas to benefit from inexpensive labor. With the current domestic economic conditions, there are rumblings that U.S. companies may work to grow domestic manufacturing and pull jobs back to the U.S. Innovations also are occurring in certain niche areas, and the shrinking cost advantage of outsourcing production is becoming more evident. Job growth continues to be a major focus domestically, and labor negotiations of major industries, such as auto makers, have demonstrated the desire for large companies to guarantee sustainability and promise to keep jobs in the U.S. 

Merger & Acquisition Activity

While the aforementioned factors have slowed down private business owner activity related to expansion and acquisitions, another business segment seems to have picked up. Private equity groups and private investors have been much more active in recent months. There has been significant rumbling in the past 18 months related to the pent-up money waiting for investment, but it seems that as the economy settles down, more potential acquisitions are being contemplated. It seems business valuations are returning to more acceptable levels for those wishing to sell their businesses, and banks are becoming more attracted to financing such deals. We view this as a great sign and a move in the right direction.

Business Succession

Each business faces unique challenges, but all ultimately need to consider, plan for and execute a succession plan. Whether it comes down to an outright sale of the company, transitioning the company to the next generation of family members or other options, such as management buyouts, this issue has to be addressed. The recent increase in merger and acquisition activity has been driven in a number of cases by exit strategies employed by many business owners. When business owners desire to sell their business, planning can have a significant effect on the company's valuation. There are several imperative activities when an owner is looking to improve value:

  • Perform due diligence on your business and your business process and activities. Many sellers believe the diligence process is the buyer's responsibility. While buyers will spend a great deal of time and effort on due diligence, performing self due diligence can overcome a number of surprises and will better prepare the seller for questions asked during the process. Being prepared when soliciting bidders will likely increase the number of bidders you may be able to attract.

During this process, you should engage in reverse due diligence by preparing the data that will likely be requested during this process. There are standard document request lists in diligence engagements, and having this information ready on the front end adds value. Delays in outside or third-party diligence have been proven to affect deal values.

Also, have your company’s financial statements audited by a firm that potential buyers consider reputable. Audited financial statements offer a buyer immediate credibility.

  • Make sure you impress upon buyers the value of the company you are offering to them. Build a business case for why the company will continue to prosper and grow and what positive effects the existing infrastructure will have on such growth.
  • Document agreements with employees and third parties. It is important for buyers to mitigate the unknowns when buying a business, so the more documentation for contractual arrangements, the better.
  • Be proactive relative to unresolved or potential litigation. Review pending or threatened claims with your attorneys and be honest about what situations exist. Resolve issues as diligently as possible. Make sure to include the effects of your focus in this area on any and all potential human resources issues that may exist.
  • Avoid accounting discrepancies, unusual transactions and changes in reporting methods. An audit, as discussed above, can assist with this. However, remember that any such instances will need to be explained and will be challenged by a buyer. Clouding facts will lead to more questions and may ultimately impact the value of your deal.

When it comes to the value of your company, you can never be too diligent. For more ideas on how to enhance value, contact your BKD advisor.

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