The Opportunity to Complement Your Business is Now

By Dave Burger | October 14, 2010
Though the economy is surrounded by uncertainty, there may be an opportunity looming for a financially sound company to expand and purchase a complementary business.

For an ethanol plant, this is a realistic option. Recently, our firm helped an existing biofuels client acquire a complementary company to enhance its core business. We believe going through the steps of due diligence, being aware of valuations and negotiations and enhancing bank relationships can help make this kind of transaction a smooth and profitable one.

One of the first and most important steps in acquiring a business is to research and understand the company's financial statements. Due diligence is important to ensure the prospect is what it claims to be. Whether it is inventory, sales contracts, equipment or buildings, everything should be verified.

Red flags involving ownership of assets may arise during due diligence. In this situation, the asset's title should reveal if it is pledged to debt. Perhaps there is a new technology or patent with the company. If so, do the research to be sure where it stands. Another situation might arise if there is a significant amount of inventory and equipment with the prospect. A little homework will uncover whether that equipment is leased and should go back to the owner at the end of the lease.

A valuation should help review the company's earnings, allowing for adjustment during unusual circumstances and highlighting areas for improvement. If an ethanol plant already has strong management, accounting and purchasing structures in place it can easily leverage those benefits on to the new business. Having wisdom, technology and a great staff puts one ahead of the curve when it comes to streamlining an acquisition.

Another key point during due diligence is to look at future earnings, not just numbers from prior years. A business may have been profitable in the past and is perhaps sitting on the cusp of a new technology that would allow better future earnings. On the flip side, the company may have lost significant contracts, which might hurt future income. The take-home message is that future earning potential may be comparable to prior years, but the buyer must be sure the expected dynamics are at least comparable to those prior years.

For example, a plant has a nearby customer who buys wet distillers grains (WDG) for a good price. Suddenly the customer doesn't want to buy WDG anymore or may close altogether. The plant may then have to dry the product and ship it, both of which add cost. This is why a review of current contracts and purchase commitments is also critical.

During negotiations, it is better to have an accounting and consulting partner involved sooner rather than later. Financing and structuring the deal from a tax standpoint is ultimately beneficial for the buyer. Getting this partner involved too late simply won't provide the best tax treatment possible.

It is no secret people do business with those they like and trust. Therefore a good banking relationship is critical to the sale or purchase of a complementary company. A bank needs to have confidence in its clients and their operations and the best way to do that is to open your doors and bring your banker to the plant. Take loan officers, credit approvers and loan committee members on a ground-floor tour, introduce them to employees. Allow the lenders to see managers working with employee teams. These things will earn confidence points with a financial institution and give loan approvers buy-in to the operation.

Never surprise your lender. Be sure to communicate your financial situation. Since most credit facilities are structured by loan covenants including minimum net worth and debt service coverage ratio, a company needs to fully understand these ratios and their impact on the plant. This is not a time to violate covenants with a lender, especially if they don't see it coming. Keeping the communication lines open lets the lender see you are doing everything you agreed to at the inception of the loan.

Buying a secondary company that enhances your core business structure is a good way to utilize the success of a solid operation. In times of uncertainty, a well-managed company can have the strength to take on a new company while controlling risk. The opportunity to grow and expand is ideal for any sound business and should be considered for sustainability down the road.

Dave Burger is a CPA and member and manager of the manufacturing group in the Wichita office of Kennedy and Coe LLC. Reach him at burger@kcoe.com or (800) 303-3241.