Anatomy of a Merger

Posted on November 1, 2004 by LCT Staff - Also by this author

The man in the nondescript black sedan tightly grips his steering wheel as the uneven patter of raindrops pelt the windshield. He ponders the grim realities of what he witnessed that evening and is still a little stunned by the fact that it’s finally over.

Even though he was more than a bystander, in the end he was helpless to do anything but watch events unfold.

Entire families would be affected. Some would mourn; others would celebrate. But this was not a murder – it was a merger – and it signaled the death of his vulnerable, failing business as it was absorbed into another, more robust one.

Why Merge?

In the majority of cases, businesses merge because one company is struggling to make ends meet and another is looking to grow. But not always.

Two strong companies – and two separate business owners – can often improve their financial status by lowering overhead, paring down their fleets to run only profitable vehicles and reducing payroll by combining redundant positions among staff members.“Businesses that are progressive and profitable can expand into new markets with a head start on permitting and licensing by joining forces,” says Charles Tenney, president of Charles Tenney & Associates, an Arlington, Texas-based consulting firm that has completed more than 125 mergers within the ground transportation industry.

“It can make good common sense for both parties to take a smaller portion of a bigger pie.”

For a company looking to expand its client base, a merger can be a shortcut to growth. In many instances, these transactions could more accurately be called acquisitions, but the term merger is often used because it sounds nicer, Tenney says.

Weighing the Risks

Bill Alford, president of VIP Limousine in Omaha, Neb., has aggressively expanded his fleet from one limousine to 62 sedans, limousines, buses and paratransit vehicles in two years. He did so by buying up just about every other company in sight – five companies in total. While exponential growth on this level seems attractive, it may be difficult to duplicate in other markets and could be potentially dangerous for most operators to attempt. Alford seemed to be at the right place at the right time and making the right choices.

Even so, he’s faced some significant challenges. He learned that the most potentially destructive problems can occur as two different business cultures and philosophies mix.

“You not only need to see eye to eye on a professional level, but on a personal one as well,” agrees Gus Sertage, president of Global Alliance in Toronto. Global was formed when Personelle Transportation and Premiere Livery successfully merged a year ago this past September. “You have to deal with people you can get along with or it could create a destructive situation,” he says.

In one instance, Alford merged with a company that did not properly maintain its vehicles or train its chauffeurs. While he always tries to retain employees from a company he acquires, it’s not always possible, particularly when bad attitudes or habits can rub off on existing employees.

Larger companies looking to acquire smaller ones should also be wary of operators who book jobs at unprofitable rates, allowing their clients to lock them in with extended contracts.

“One company we bought made some verbal promises to clients that we didn’t even know about until after the deal was done,” Alford relates. “We had two choices – lose the customer or suck it up and do the job at a loss.”

“If you are buying a company, their rates should be equal to or greater than yours,” says Tom Mazza, an industry consultant who handles mergers for operators.

Seller Beware

Just as buyers need to be cautious before they fork over a load of cash, sellers need to protect themselves from unscrupulous people who don’t plan to pay the amount agreed upon in the contract. Even family members have been known to get nasty and behave ruthlessly when enough money is involved, so it’s important to watch your back. The following 10 tips are for operators looking to sell their companies:

1. Check out the buyer. Do a credit and security check, talk to vendors, bankers and other operators. Just because someone appears to run a big company, doesn’t mean he pays his bills.

2. Make sure you have something to sell. People are paying for accounts 80 percent of the time. “If you want to get a decent amount of money for your business, you need to build real accounts, a quality staff and a good reputation,” Tenney notes.

Vehicles are often only a small part of these transactions.

3. Get as much cash up front as you can, but be sensitive to the buyer’s risk or you will never make a deal. If a company is performing well, the owner should be able to get cash in the deal, but 80 percent of all acquisitions occur because nonperforming company owners need a way out. They grow tired of the endless treadmill of putting in 70 hours a week without ever earning a fair wage. It’s not uncommon to work twice as many hours and get paid half as much as a successful chauffeur – and a chauffeur doesn’t have the impending doom of debt hanging over his head, Tenney says.

4. If there are performance terms in the contract, make sure the buyer can handle all new business. If not, he’ll lose the accounts and you’ll lose your money.

5. Don’t do anything on a handshake. Make sure you bind the buyer legally. You do need attorneys.

6. Write an “out” clause into the contract in case things go awry. This may include penalties for lack of payment or give permission for legal recourse.

7. Include a take-back clause provision, which says: If the buyer doesn’t perform according to the contract, you will get the business back. This can occur with nonpayment or a lack of financial reporting to a seller in a contract that has performance terms.

8. Don’t forget yourself. Make sure you add in a reasonable salary for yourself, particularly if you run a one-man show, Mazza advises.

9. Only reportable income has value. An operator who hasn’t been entirely honest with the IRS about his earnings could get burned in a merger. Buyers want a financial statement that lists assets and liabilities.

10. Be realistic. “Don’t expect to be paid high retail for your vehicles,” Mazza says.

Buyers Be Methodical

The process of checking out a company that you’re purchasing can be tedious and time-consuming, but it’s essential to know what you’re getting for your money. The following 10 tips will help buyers protect themselves from bad deals or sellers who may be misrepresenting their businesses.

1. Dig deep investigating a potential company. Start by getting a third-party evaluation to help ensure you don’t overpay. “You also need to know how much debt this person has and how many trade accounts they maintain,” says Michael Zappone, president of All Transportation Network, a company that’s completed 10 acquisitions and has bases in Connecticut, New York and New Jersey. “These are things that can bite you in the backside.”

2. Confirm that accounts will stay with you. Go to the top 10 accounts and ask, “Is there any reason you wouldn’t stay with me if I purchased this company?”

3. Tie a performance clause to the payment program. According to Tenney, a typical merger may include paying half of the selling price up front, then 25 percent after 12 months, if 90 percent of the accounts remain. The final payment can come at the end of the second year if 90 percent of the accounts have still been retained. “If not, the price would be reduced by a proportionate amount to the seller,” Tenney says.

4. Include a non-solicitation agreement. Non-competes can be difficult to enforce due to restraint of trade issues. But a non-solicit clause simply says a person will not solicit specific accounts, making it much easier to enforce. Make sure all employees sign the non-solicitation clause. Otherwise, drivers and key employees can go into business for themselves and steal your biggest clients or go to another company and take clients with them.

5. Buy assets, not the business, wherever possible, so you don’t take on liabilities, Alford notes. “If you acquire a company and someone was sexually harassed, you could be liable.” Assets may include business lists, vehicles, accounts receivable and licenses.

6. Make sure you have the time to make the deal. A merger can take you away from your core business for months, Tenney warns. Negotiations and due diligence are slow processes. If you can’t afford the time, reconsider your position.

7. Understand your new customers’ expectations – on both price and customer service. If your new clients are used to paying rates that are 20 percent lower than yours, it could be a problem.

8. Protect the phone numbers of the company you purchase. Call the phone company and get a new account number and a new security code. “We had a guy call the phone company one time and point his old phones to his home instead of my company, even though we were paying the bill,” Zappone recalls.

9. Develop a marketing transition plan. Inform your new clients about what is happening. “We use our newsletter to welcome the new clients and tell them what’s going on, who we are and what they can expect from us,” Zappone says.

10. Don’t sit down at the bargaining table until all the parties involved are present. “If they have multiple owners, they all need to be there,” Sertage warns. “Otherwise, you could spend a lot of time and energy trying to convince one person, only to find out later that another owner never wanted to sell to begin with.”

Getting Financing

The Small Business Administration (SBA) can be a good option for business owners seeking loans to expand their businesses. Just make sure you have a well-written business plan, a marketing plan and all necessary financial information when you sit down to request a loan.

For assistance and advice, try calling the SBA’s Service Corps of Retired Executives. SCORE is a nonprofit association providing entrepreneurs with free, confidential face-to-face and e-mail business counseling.

Operators aggressively seeking to acquire additional companies will need money, often lots of it, according to Zappone.

Banks want to see that you’re willing to invest some of your own money. That can mean taking your working capital and investing it, which can be risky. Zappone warns operators to be cautious about over-extending themselves financially.“Make sure you have enough cash to support the deal,” he says.

Components of a Big Acquisition

There are series of steps that should be followed to get the best results out of an acquisition. When dealing with an acquisition valued at over $1 million, Charles Tenney recommends the following:

The process starts when prospective buyers create what Tenney calls a deal flow, meaning they begin to consider and investigate their opportunities.

Buyers may ask themselves, “How do I find targets?” That alone can be a major time-consuming process. The majority of the work is in this one step, which is why Tenney’s clients often outsource that job to him.

Once you find a company that meets the profile you’ve developed, negotiate to reach an agreeable transaction, which includes price, terms and structure. From this, a purchase contract is drafted.

Next, both sides will want to conduct due diligence. They’ll want to confirm everything they were told about the other business. Are the company’s legal structure, bank accounts, permits and fleet as advertised? Are employees coming along in the transaction?

Due diligence is often best carried out by a third-party escrow company.

Next, financing must be found. The Small Business Administration (SBA) is a great place to go. Most deals are seller financed or there is at least seller participation.

Next is closing. This entails sitting down at the closing table to ensure everyone follows what was established in the contract. Transferring titles and leases are part of this. “It’s similar to buying a house,” says Tenney. “You go to a title company and they make sure all the documents are signed and everyone is paid.”

After that, comes the transition. If this is not done correctly, everything else will be lost. “I saw a company one time that didn’t do the transition correctly and lost half of its accounts,” Tenney says.

As part of all this, buyers must communicate to new customers what is happening. There can be no service interruptions, no surprises. You don’t want to give clients any concern that you as the buyer cannot handle the job.

Next is where merging culture comes into play. People need to feel comfortable working with each other and get along. For instance, the employees at one company may not be allowed to use profanity, while the employees from the other company curse like sailors.

The owner also needs to determine who is going to run things. Some people don’t take orders well, particularly if they spent the last few years giving them.

The loss of certain people can mean losing key accounts, so you have to be careful. Credit policies must be the same or properly integrated.

Finally, technology transitions have been know to be problematic, so plan for these to be merged smoothly. It’s a delicate dance, and all part of making a merger successful.

Blending Cultures

Mergers and acquisitions combine more than just fleets and assets. Perhaps even more importantly, they often bring together two completely different corporate cultures and business philosophies.

There are typically three ways to ease this transition. The two cultures can coexist independently; one culture can dominate and eventually absorb the other; or the cultures can blend characteristics and form a new one.

Experts agree that a proper blending of cultures is the best scenario, although it may seem like the most challenging one.

Often, the seller’s company is absorbed into the culture of the buyer’s without regard to the consequences. However, better results are found at companies that encourage trainers, other employees and decision makers to support the process of cultural discovery and dialogue.

By examining the two cultures and opening a dialogue between employees of the two organizations, you will promote understanding and acceptance.

To initiate this blending, a group of employees from the acquiring company should be asked to assess their own culture and identify what is good and bad about it. This may include an assessment of relationships between departments, whether employees are encouraged to offer input or seek innovations and whether they feel as if management sets clear goals for them.

Once these employees have conducted their cultural self-assessment, bring them together with your new employees and begin a dialogue about goals and business practices.

New employees should be encouraged to participate and offer assessments of the business culture to which they have grown accustomed. The key to success during this step is to create a comfortable setting, like people sitting around a campfire. The goal is to reach some level of mutual understanding.

Have people take turns, allowing everyone to share their thoughts without interruption. Then encourage an open conversation where new employees can ask questions and share how their cultures are similar and different. Let differences emerge naturally. Conclude the session by asking each employee to share one or two insights about either culture.

If more dialogue is deemed necessary, schedule follow-up sessions.

Providing each employee with the opportunity to participate in a cross-cultural dialogue is a significant first step when merging cultures. If both cultures are strong and the characteristics are opposed, more work may be needed.

Management should be open-minded, but may be forced to choose which characteristics of each will survive the merger. This is a big component of what defines the new organization.

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