David McCully

With this in mind, understanding and managing the downside risk of a transaction is as important as identifying a quality acquisition target with the right products, services and market. Bottom line:  Buying a business can be risky. Consider the following tips when it comes to evaluating your next deal.

Have a well-defined acquisition strategy. Much like following the recipe for your favorite dish, it is essential to have a well-defined acquisition strategy and stick with it. It all starts with determining what constitutes an attractive acquisition target for your organization. This vision must be kept top of mind throughout the process to avoid impulse buys or deals driven by emotion, as these rarely generate optimal investment decisions. During the due diligence process, you may uncover findings about your target that are at odds with your strategy. While these findings may or may not cause you to pass on the deal, it is important to protect your organization and investors at all times. In other words, you should always be in a position to walk away from a deal if you learn the fit is simply not right.

Know your exit strategy before inking the deal. Similar to real estate transactions, the majority of gains on M&A deals are made on the buy side. To truly evaluate the deal, however, it is essential to consider your intended exit strategy. Exit strategies can take many forms, and all have a variety of cash flow and tax implications. Some of the best deals lend themselves to multiple exit strategies, so you need to identify those now while considering your likely buyers (or successors) as well as timing. It is always a good idea to design your business plans with your exit strategy in mind. This allows you to determine the right capital structure, entity type and pricing strategies needed for long-term returns. Quality time on the front end answering these questions with your trusted business advisors, including your CPA, is a must.

Understand the real value of the transaction. It is no secret that the recent M&A marketplace has been crippled as a result of the credit crisis and economic cycle. However, deal-making activity appears to be on the rise. Valuations based on multiples of earnings before interest, taxes, depreciation and amortization (EBITDA) are decent rules of thumb, but in this market the balance sheet has once again become a critical element. Accredited business valuation professionals rarely rely on EBITDA multiples and neither should you. Determining value requires a solid understanding of the balance sheet. The real value is measured in terms of actual, after-tax cash flows and by the deal’s expected internal rate of return. There are no shortcuts here. Simple earnings multiples may be an effective ballpark estimate used to limit the field of investment alternatives, but they are not a shortcut when it comes to determining the real value of a deal.

Tie up all loose ends before closing the deal. Purchase agreements, which outline the deal terms, responsibilities, representations and warranties of both the buyer and seller, can often be lengthy legal documents negotiated over time. If your purchase agreement specifies the execution of noncompete, non-solicitation or employment agreements or if it includes a seller note, escrow or indemnification warranty as part of the deal, it is up to you and your team of advisors to ensure these and other agreements are both papered and funded prior to closing the deal. Once the ink dries, you lose bargaining leverage and your return on investment may suffer as a result.

Conduct a rigorous, in-depth due diligence process. Due diligence is much more than a financial audit. Many due diligence procedures are aimed at simply validating historical cash flow or obtaining evidence supporting balance sheet assertions of the potential acquisition. While these procedures are important, it is also critical to use this window of opportunity to carefully evaluate other business matters beyond what traditional accounting, legal and environmental due diligence will explore. Some things to think about may include:

• Who are the key players in the business?
• What systems, processes and key controls exist?
• Are procedures effective to safeguard your investment?
• What is the competition doing?

These represent a small sample of critical business questions. You deserve factual answers that will aid in your evaluation of the investment opportunity.

For more information on this issue or related matters, please consult your BKD advisor.