Mergers and Acquisitions For Dummies (30 page)

Phase II:
If, based on the findings in the Phase I review, the examiner believes the property may have issues, a Phase II may occur. A Phase II is a more in-depth, on-premise review and analysis. Some of the problems the Phase II tries to uncover include nasty things such as radon, asbestos, and other hazardous materials.

Buyer may include an environmental assessment as part of due diligence, but it may make sense for Seller to go ahead and conduct a Phase I prior to the M&A process. If the Phase I is clean and relatively recent, Buyer may be able to skip further environmental testing, thus saving time.

Depending on the consultant's findings, Buyer may be in a position to demand strong representations and warranties as part of the deal if the land presents an environmental problem. Speak to your attorney for more advice.

Seeking friendly advice: Using friends and family as informal advisors

Friends and family are the whipping boys of the business world. Emotional pals and relatives call on them to fund all manner of crazy start-ups. Then the loved ones want free advice! Luckily, friends and family are usually willing to offer advice and thoughts about doing a deal.

Friends and family probably aren't helpful guides for all the small details and tiny nuances a deal-maker encounters while delving in to the world of M&A. But even though they may not be M&A experts, they probably know the deal-maker better than most people and can therefore be a good source of opinion about the big issues (such as whether the potential Seller should sell).

Skipping business appraisers

Business appraisers
are people who offer the “service” of valuing a business. Sometimes this service is offered as part of another advisor's product offerings; for example, many investment bankers and business brokers (which I discuss earlier in the chapter) also offer the “service” of appraising a business and determining valuation.

I put “service” in quotation marks for a simple reason. In my humble opinion, business appraisals aren't helpful. They merely put a valuation number in Seller's head, and that number quite often doesn't make any sense because the appraiser's valuation techniques are mostly guesswork. Sure, the guesswork can have impressive methodology — I'll be generous and call it an academic exercise — but the only true measure of a company's worth (what someone else will pay for it) is missing from any and all academic exercises.

Beyond providing a number rooted in no rational basis, the appraisal may raise Seller's expectations and cause him to reject the market value of his company. Worse, the actual market value of a company may be perfectly suitable to fund Seller's desired lifestyle, but that high appraisal number may lead him to opt against selling the business.

I have firsthand experience in how business appraisals can be counterproductive, if not downright destructive, to wealth creation. A company I approached for my client, an acquisition-minded Buyer, ultimately had to pass on our offer. The owner was interested in selling, and the offer price was suitable for his needs, but because the company had an employee stock ownership plan (ESOP), it was required by law to have an annual appraisal. The last appraisal valued the company at 15 times EBITDA, which was significantly above our offer price of five times EBITDA. Because the owner had a fiduciary responsibility to his employees (because of the ESOP), he was unable to accept our offer.

As a result of an inflated and ultimately arbitrary appraisal price, the owner was unable to do a deal. The upshot was that an illiquid asset remained illiquid, no taxes were paid as the result of the sale, no fees were earned by the advisors, and the business didn't receive a new owner who would have invested in the business, possibly creating more opportunities for the existing employees and employees yet to be hired.

What do Buyers think of an appraiser's valuation? They don't. The valuation an independent appraiser, someone with no skin in the game other than the fee he's charging Seller, is of zero value to Buyer. People in the M&A industry may say otherwise, but they're just being nice. A business appraisal isn't worth the paper it's written on.

Bottom line: Sellers should let the market decide the value of their businesses.

Keeping Everyone on the Same Page: Avoiding Communication Breakdowns

To steal Strother Martin, Jr.'s, immortal line from
Cool Hand Luke
, “What we've got here is failure to communicate.” Well, I think Strother drawled it “cahmun'kate,” but you get the idea. Communication breakdowns may make fine fodder for rock 'n' roll songs, but a failure to communicate can be major problem and even a death knell for the M&A process.

Communication problems typically come in one of three flavors:

Purposely communicating incorrect information:
You may know this better as
lying.
Unfortunately, many people conveniently forget the benefits of honesty, which is why due diligence is a necessary part of the M&A process. (Chapter 14 gives you more info on performing due diligence.)

Not communicating information:
This version is lying by omission. Seller has the obligation to divulge any information that may be construed as
material
(important).

Inadvertently communicating incorrect information:
Unintentionally signaling the wrong information can weaken one side's bargaining strength because the other side may think it has an advantage where it didn't know it had before. But in some cases, it can prove fatal to a deal because the other side may think something is wrong and bow out of the a deal.

To keep your team of advisors on the same page, here are three tips to avoid communication breakdowns:

Establish a chain of command.
One person should be the point-person when dealing with the other side. All requests for data, meetings, follow-up questions, and so on should be routed through that person.

Although this suggestion may sound like creating more busywork and bureaucratic layers, a failure to institute and follow a chain of command results in cross-communication, duplicated steps, and general frustration such that emergency conference calls and meetings become necessary to get the process back on track.

Assign specific roles and tasks to each team member and hold each member accountable for fulfilling that assigned role.
Some of the specific tasks the deal-maker needs to determine are

• Who makes the calls to the prospective Buyers or Sellers?

• Who is responsible for structuring the deals and making sure the deal makes economic sense for the company?

• Who is the final authority for green-lighting a deal? In other words, who has the final say-so?

• Who is the point-person with outside advisors?

• Who makes site visits?

• Who leads management meetings with the other side?