This article is the second in a two-part series on acquisitions. See the August issue of Contracting Profits for part one on selling a company or division.

No one goes into business to be mediocre. The dream is to be the biggest and the best, which requires constant growth. One way to achieve that goal is through acquisitions. Purchasing an established company is an excellent opportunity to beef up your own operation without starting from scratch.

Buying a business is a lot like buying a used car. There are many great deals to be had, but there are also some lemons in the bunch.

“The mergers and acquisitions process is a risky game,” says Chris Clifton, president and COO of St. Paul, Minn.-based Marsden Building Maintenance LLC. “Oftentimes acquisitions don’t live up to expectations.”

To make the purchasing process a success, it is important to go into it for the right reasons and to be well informed and fully prepared for potential obstacles.

The right timing
The motives behind acquiring another business or division should always be strictly strategic, never ego or desperation. Buying a company simply to impress your peers is a recipe for failure. Likewise if a building service contractor’s current company isn’t successful, adding a second business or location will only double his or her losses.

“There are people who get caught up in acquisition for the sake of acquisition,” says Gary Penrod, owner of Gary Penrod & Associates Inc., a building service industry-specific merger and acquisition firm in Hilton Head Island, S.C. “They try to buy too many companies that are too small and don’t add to the strategic value of their own company. That’s a mistake. It has to be strategic and selective.”

There are good reasons to buy another company or division, including expanding into a new marketplace or category. A BSC in Chicago who wants to grow his business by creating a presence in St. Louis may decide to buy an established BSC in that city. Or a retail-specialist BSC who wishes to become a full-service operation might purchase an industrial BSC to augment his offerings.

These purchases come with facilities, a customer list and credibility — all of which would take substantial time, money and energy to reproduce from the ground up.

“The decision to grow through acquisition should be arrived at as part of the firm’s strategic planning process,” says Jim Peduto, president of Matrix Integrated Facility Management in Johnson City, N.Y. “As a prospective buyer, you should be able to clearly describe your ideal acquisition target.”

A buyer must have more than good intentions — he or she must also have good credit. Buying a business is a big investment that comes with a big price tag. Whether the money will come from cash reserves, a bank loan or private investments, financing should be clear before the search for a business begins. Business owners must know how much money they are able to spend before they get caught up in the excitement of negotiations.

“You have to be sure you have the financial resources to do it,” says Vince Elliott, president and CEO of Elliott Affiliates in Hunt Valley, Md. “The last thing you want to do is gamble on an acquisition being successful. There are too many ways for it to go wrong. Can you afford to do it and take the risk? You have to be honest with yourself.”

Getting started
Once financing is secured, the next step for buyers is to find the business or division they want to buy, which may be easier said than done. There are two ways for buyers to locate a potential target for acquisition — conduct the search themselves or hire a professional to do it for them.

If owners plan to scout themselves, they should research the market (geographic or service) that they wish to enter. Then buyers should determine who the players are in that area and decide which ones, based on size and clientele, they are most interested in. Finally, call the CEOs of those companies and ask if they are open to a purchase proposal.

Owners shouldn’t be afraid to approach a well-seasoned pro or an up-and-coming star — after all, it’s never quite known when someone is ready to retire, wants to relocate or is looking to become part of a larger operation.

If buyers are going it alone, they may find it easiest to approach entrepreneurs with whom they already have an established relationship. To this end, it may help potential buyers to attend industry association events before they start making their preliminary calls.

While many acquisitions still happen at the one-on-one level, more BSCs are turning to third-party intermediaries to guide them through the process. A professional can take some of the guesswork out of finding the right target and he will make the process less personal.

“The merger and acquisition person will pick up the phone and canvas for you,” Elliott says. “If there’s any risk at all, it’s smart to have the third party involved.”

An intermediary will hold an owner’s hand throughout the purchasing process, including the sometimes difficult negotiation period, which begins with preliminary discussions. This is the time to analyze the business, including customer contracts, financial statements and employee records.

If an owner is satisfied with what he or she sees, then the next step is to agree on a price and what will be included in the sale and spell these things out in a term sheet. Once both parties are on the same page, the buyer delivers a letter of intent as a demonstration of good faith, which the seller accepts or declines.

At all points during the process, buyers must remember to go slow. Getting overly eager to close a deal can lead to mistakes or disappointment.

“I had a client that was so committed to getting the deal done that he made numerous concessions and ultimately took a deal on less favorable terms,” says Peduto.

Due diligence
Once the purchase agreement is in place, the real work begins. Due diligence is the final stage of the buying process, when the buyer has access to all of the seller’s records. This critical step is the buyer’s last opportunity to investigate any claims made by the seller and to verify that any information presented is accurate. In other words, it’s the time to look under the hood and kick the tires to make sure you’re not buying a lemon.

While the profitability of the company you are buying is important, a thorough due diligence goes well beyond financial analysis. In addition to reviewing the books, use this time to:

  • Check for lawsuits or liens against the company;
  • Look through customer and supplier contracts to make sure terms are acceptable;
  • Review employee benefits plans and workers’ compensation claims;
  • Inspect equipment for repair or replacement issues;
  • Read insurance plans to find any gaps or lapses in coverage;
  • Create non-compete agreements for departing staff;
  • Make sure there are sufficient organizational documents to ensure a smooth transfer of power.

Given how important and complicated due diligence is, it’s wise for owners to hire a lawyer and an accountant to walk them through the process (if BSCs must go it alone, there are due diligence checklists available for purchase online). Also, don’t shortchange this step. Many buyers agree to one-week due diligence periods, but several weeks or a month are best to be sure no stone is left unturned.

“Having a team of professionals ensures that the entire process flows smoothly,” Peduto says. “A good team will have experience drafting the necessary documents and will save you from reinventing the wheel.”

Completing the sale
Armed with the information uncovered during due diligence, the buyer can then go back to the seller and demand concessions in price or terms.

“It’s in the buying company’s interest to find everything wrong with it to get the best price,” Elliott says.

Instead of shaving a few dollars off the sales price, Elliott suggests that buyers consider more innovative deals. For example, on a $100 million sale, a buyer might offer $20 million upfront and the remaining $80 million spread out over the next four years, contingent on profits increasing by X percent.

“Then the seller has a stake in making sure the business does well,” Elliott says. “In fact, some sellers insist on [such deals] because then they know it’s a relationship.”

Once the agreement is finalized, the final paperwork is filled out and the sale is closed.

Purchasing a business or division can take several months or a year. It’s a long and complicated process, but if done with care, it will be worth the time and effort.

“After you’ve done it a few times you know how it happens and it gets easier,” Elliott says. “Just remember that the biggest value in the whole deal is the customers, those you are buying into. That’s where the money comes from.”

Becky Mollenkamp is a business writer based in Des Moines, Iowa. She is a frequent contributor to Contracting Profits.

Editor’s Note: Jim Peduto will be speaking at ISSA/INTERCLEAN® North America in Orlando, Fla. on Tuesday, Oct. 23. His presentation titled “How To Construct a Manageable Budget” is sponsored by
Contracting Profits.