Is it a Good Time to Acquire a Business?

JOEL HERMAN, CPA

This past year has seen continued financial concerns about inflation, rising interest rates and skilled labor shortages. While some manufacturers have struggled, others have been very successful, surpassing expectations and looking to expand.

Business acquisitions can be both tempting and tricky. Is 2024 the year to grow by acquiring a distressed business?  

What to look for

While acquisitions of turnaround candidates or distressed companies have the potential to yield significant long-term rewards, acquiring a troubled target can also pose greater risks than buying a financially sound business. The keys are choosing a company with fixable problems and having a detailed plan to address the deficiencies.

Look for a company with hidden value, such as untapped market opportunities, poor leadership or excessive overhead costs. Also consider cost-saving or revenue-building synergies with other businesses that you as the buyer own. Be sure to assess whether these opportunities exceed acquisition risks and potentially provide ample financial benefits.

Due diligence

Successful turnaround acquisitions start by understanding the target company’s core business — specifically, its profit drivers and roadblocks. Without a clear understanding, you may misread the company’s financial statements, misjudge its financial condition and, ultimately, devise an ineffective course of rehabilitative action. This is why many successful turnarounds are conducted by corporate buyers in the same industry as the sellers or by investors (such as private equity funds) that specialize in a particular sector.

During the due diligence phase, pinpoint the source of your target’s distress, such as excessive fixed costs, decreased demand for products and services, poor management, unnecessary overhead or overwhelming debt. Then determine what, if any, corrective measures can be taken. Do not be surprised to find hidden liabilities — such as pending legal actions or deferred tax liabilities — beyond those that are more apparent.

You also may find potential sources of value, such as tax benefit carryforwards or proprietary technologies. Benchmarking the company’s performance with its industry peers’ can help reveal where the potential for profit lies.

Cash-management plan

Before completing a transaction, determine what products drive revenue growth and which costs hinder profitability. Review the product mix and determine if it makes sense to divest the business of unprofitable products, subsidiaries, divisions or real estate. Evaluate personnel and job descriptions to determine if a reduction of staff makes operational and financial sense.

Implementing a longer-term cash-management plan and developing a short and long term cash-flow forecast is also critical. Cost-saving and revenue-generating opportunities, such as excessive overtime pay, high utility bills, excessive scrap and unbilled services, can be achieved with a strong cash-management plan and a thorough evaluation of accounting controls and procedures.

Reliable due diligence hinges on whether the target company’s accounting and reporting systems can produce the appropriate data. If these systems do not accurately capture all transactions and list all assets and liabilities, a potential buyer will not be able to track progress and fully pursue growth opportunities or respond to potential problems.

How to structure the deal

When acquiring a business, the parties can structure the transaction as a sale of either assets or stock. Buyers generally prefer asset deals, which potentially allow them to omit certain non-desirable items from the company’s balance sheet. In addition, the buyer receives a step-up in basis on the acquired assets, which provides them future tax deductions in the form of depreciation, amortization and asset write-offs. In addition, it can allow the buyer to negotiate new contracts, licenses, titles and permits.

On the other hand, sellers typically prefer to sell stock, not assets. Selling stock can simplify the transaction, and allow the seller a favorable capital gains tax treatment.

However, stock sales may be riskier for buyers, who “step into the shoes” of the seller and take on all debts, legal obligations and other “skeletons in the closet”. In a stock sale, the buyer also inherits the seller’s existing depreciation schedules and tax basis in the company’s assets.

It is your choice

The decision to merge or acquire another manufacturer will be different for each business, as situations differ, and there may not be a perfect choice. Completing thorough due diligence is a must. Before taking the leap, call your financial and tax advisor. These trained professionals can help you develop a strategic plan that maximizes your long-term value, while also minimizing potential risks.

For more information, contact your ORBA advisor or 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.