As a long-time mergers and acquisitions specialist and a past chapter president for the Association for Corporate Growth, I have seen many examples of acquisitive companies that don’t really understand what matters most in terms of corporate due diligence. This has occurred across a wide range of consolidating industries, and the landscaping and lawn care industry is no different.
The tragedy of this is that oversights in the due diligence process can take away much – if not all – of a deal’s value. This problem is a constant theme during meetings with fellow ACG members, among them experienced corporate development officers, investment banks and consulting firms. However, poorly executed due diligence does not have to cause irreparable harm to a deal. With a focused approach, oversights can be overcome.
NUMBERS CAN LIE. As an example, picture a family-owned landscaping business, which found what appeared to be an ideal acquisition for its plans to both move into upscale neighborhoods to grow its residential business while also expand from residential to corporate services with the acquisition of some commercial accounts. All of the “numbers” from due diligence looked good to the family-owned business, which saw the acquisition as an opportunity to accomplish these goals. Hence, the deal was done.
Within several months, however, the acquired business began to lose money. The marketplace had not changed, yet the numbers indicated trouble. A consultant was brought in to get to the root of the problem.
The analysis revealed that while the new division’s primary business was profitable, there were many commercial contracts that had been underbid and, thus, were being grossly over-serviced. These contracts were depleting resources from the profitable residential contracts, resulting in overall negative net income and eroding competitive position even in the company’s traditionally strongest markets.
Management acted quickly, redirecting personnel from unprofitable client sites to profitable sites to better align the services delivered with the revenues generated from these commercial accounts. Within six months, the commercial side of the business had returned to profitability.
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Few people can speak so authoritatively on the due diligence process for landscape companies as Ken Garcia, senior vice president and chief development officer for LandCare USA, Houston, Texas. Garcia and his colleagues have successfully completed due diligence on nearly 30 acquisitions in the last 12 months, and while he recognizes that due diligence is rarely an enjoyable process for the sellers, he pointed out that understanding the process ahead of time can make it run more smoothly for all involved. Speaking on the topic of “Conducting Bullet Proof Due Diligence” at the second annual Landscape and Lawn Care Industry Mergers and Acquisitions Institute in San Fransisco, Garcia noted that the goal of due diligence from the buyer’s perspective is to illiminate any surprises that his company could encounter after closing the deal. He pointed out five key areas LandCare USA focuses on in its due diligence, which typically take 45 to 60 days: financial, operational, risk management, legal and environmental. Regarding financial performance, Garcia said he has been surprised by how many landscape companies operate without detailed and realistic projections of their future financial performance. Such projections are of particular importance to an acquiring company because that company is looking to acquire the target company’s future earnings. A company’s operational history – how it handles human resource issues, the depth of its talent pool, how long employees have been with the company – is also of importance to an acquiring company. – Bob West |
COMMON HEADACHES. As this example indicates, the “morning after” with an acquisition can be similar to the “morning after” following a romantic fling. What looked great the night before may lose its glow in the day-to-day world of running a business. Even an extended courtship – or exhaustive due diligence – may fail to find all of the potential trouble spots.
“Morning after” headaches that due diligence may not typically reveal include the following:
• Competitive strength not what the acquired company thought – Declining market position can be hidden by the numbers – at least for a while. Acquiring companies can be lulled into thinking that a company with increasing gross margins and cash flow cannot be threatened by eroding market share.
• Aging equipment – Pending obsolescence of capital equipment can be overlooked because of the seduction of solid financials. Strong net income and cash flow may mask deferred investments in new, more efficient equipment that will ultimately be required of the acquiring company.
• Customer franchise or reputation not what the acquired company thought – Verifying the loyalty of customers can be difficult. The company being acquired may object to customer contacts from fear of creating unrest. In addition, there’s no way to anticpate how a change in ownership will affect the customer base.
• Unprofitable contracts – A company being acquired may be profitable overall, but may also have individual contracts that repeatedly under-perform, as indicated in the earlier example. With solid portions of the business propping up unprofitable segments, it may take several “mornings after” for the problem to reveal itself.
• Valued key employees with one foot out the door – Due diligence cannot tell you which key members of management, sales or production are planning to leave. A pending sale may cause individuals to begin a job search. Sloppy melding of human resource policies and procedures can also be disastrous.
• Incompatible cultures – The most serious “morning after” problem is a clash of corporate cultures or value systems. One company may be a pioneer, while the other is traditional; one analytical while the other is intuitive; one structured while the other is fluid. A culture clash can kill assimilation, resulting in failure to achieve synergies that otherwise made the merger attractive, especially if key personnel from the acquired company do not support the new ownership’s philosophies.
FIXING THE PROBLEM. After a company determines it has “morning after” problems, the next question is, ‘what are we going to do about them?’
• Determine why – Before new ownership can attack the problem, it has to determine root causes. Are there external factors, such as changes in the marketplace, or internal problems, such as aging equipment? To gain a clear understanding, outside assistance may be necessary, particularly as it can lend an unbiased eye toward the acquiring company’s plans.
• Develop a credible plan – After understanding the nature of the problems, the next step is to develop a specific action strategy. Does the assimilation plan need to be reworked? Are the right people in the right positions? Do contracts need to be renegotiated or terminated? Including personnel from the acquired company in this process can be particularly valuable toward retaining them.
As simple as this approach to a remedy sounds, there can be many impediments to a “morning after” cure:
• Too much diversity – If the acquired company is in a different industry segment than the new owners, such as focusing on commercial clients instead of residential clients or primarily offering lawn care services instead of maintenance, the acquiring company may lack the necessary knowledge to correctly diagnose the problem, take decisive action and formulate a successful solution plan. This problem makes the case for steering away from acquisitions in which the acquiring company would be in trouble if it had to rely solely on its own expertise to make critical decisions early on after the acquisition.
• Reluctance to act – Many companies lack the stomach to take painful medicine. Even in the face of clear warnings, management and directors may fear making a bad situation worse.
• Denial – If management or directors lobbied for an acquisition, there may be denial on their part to admit that a particular problem exists. Individuals who advocated the deal will often be reluctant to admit they made a mistake.
HAVE YOUR EYES OPEN. Because “morning after” problems have become common, a growing body of principles is forming in dealing with these situations.
• Err on the side of acting too fast – Unless you have objective information that tells you to react slowly, such as a seasonal down-cycle in the market, it is better for new owners to move quickly. Value lost early in the post-acquisition period can never be recovered.
• Make sure you know why the business is broken – The fewer things that are broken the better your chances are of fixing them. While it is important to act quickly before a problem grows worse, rushing to make changes without full knowledge of the situation can be a disaster. Of course, your chances of repairing a business are greater if it has never been broken and fixed before.
• Beware of culture clashes – The business press is filled with stories of mergers that have failed, and the most common element in these situations is a clash of cultures. Due diligence that focuses only on the numbers is not enough. Many companies have increased the odds of a successful integration by arranging for the employees of the two companies to meet before they have to start working together at a picnic, sporting event or some social function.
Just as examples of a failure to address “morning after” problems abound, there are many success stories.
For example, another landscaping company acquired a family-owned competitor serving a special niche. Because the acquired company was a family-owned business, there was concern over inter- family issues. To avoid “morning after” blues, these issues were identified and resolved before the merger was closed.
In addition, the acquiring company recognized that the company it was buying had the better name recognition and a stronger franchise. After the merger, the acquired company became dominant in the new organization, with both companies operating under its name in the market. Key management personnel of the acquired company were promoted to head the overall organization, resulting in a powerhouse brand that took advantage of the opportunities available to it.
The key point is this – “morning after” problems are more the rule than the exception. While due diligence can reduce surprises, it cannot and will not eliminate them. The key to making the integration of the two companies successful is to recognize problems early and take decisive action to solve them. Even a marriage with a rocky start can lead to years of wedded bliss through planning, compromise and a shared vision of the future.
The author is president and CEO, Norelli & Company, Charlotte, N.C. He can be reached at 704/376-5484 or at Rnorelli@norelli.com.
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