Oct. 25, 2021

This paid piece is sponsored by Eide Bailly LLP.

A version of this article previously appeared on EideBailly.com.

By Amber Ferrie, CPA, ABV, CFF, CM, AA, and Chad Flanagan, CPA, ABV

Mergers and acquisitions have always been part of the history of corporate America. The same is true of the Sioux Falls-area business community. And now, more than ever, the merger and acquisition market stands poised to help organizations navigate through the economic uncertainty caused by the effects of COVID-19.

M&A activity continues to build momentum from a quick vaccine rollout while market sentiment remains strong into the latter half of this year. Business owners are seeing healthy revenue following economic recovery while using cash stockpiles to fund investments formerly put on hold in 2020. Wavering uncertainty in the market and ample dry powder have corporations and private equity groups poised to continue unloading capital.

Despite fluctuating market conditions because of COVID-19, there is never a wrong time to begin preparing for an eventual sale. Merger and acquisition activity is important to consider, regardless of the size or industry of your organization. Buyers are looking for management teams who know what they’re doing and have defendable growth projections, and these are two things you can always focus on.

Important M&A items to consider

Divesting or acquiring a business may seem like a monumental task. The key to a successful transaction could be summed up in one word: information. There always will be an element of risk involved in transactions; however, starting the process with certain questions and an understanding of topics will act as a road map that can lead to an informed decision of what is best for your organization when performing accounting for acquisitions.

Adjusted EBITDA

Middle market deal prices often are traded based on adjusted EBITDA. Adjusted EBITDA is a term used in transactions to identify unusual and nonrecurring events that have impacted EBITDA. For example, the seller may have certain discretionary expenses, relatives on the payroll, nonrecurring incentive income or accounting policy differences during the periods being analyzed.

Additionally, current accounting policy elections could impact the analysis of historical EBITDA should the new owner require or desire policy changes after purchase. One example could be whether the new owner will elect FIFO versus LIFO as an inventory method. If the desired inventory method of the buyer is different from what the seller is using, adjustments should be made in calculating adjusted EBITDA so that the buyer can make an informed decision.

COVID-19 adds another layer to the adjusted EBITDA conversation. With the potential for lost revenue because of COVID-19, many organizations will be searching for ways to counteract revenue declines in their financials for upcoming quarters. In other instances, revenue saw spikes and accelerated a change in consumer behavior; however, some buyers are skeptical of these revenue abnormalities and shifts as they are uncertain if they can be repeated on an ongoing basis. Either way, many in the merger and acquisition profession are questioning whether these types of COVID-19 based calculations will be fully accepted as EBITDA adjustments.

Working capital

Sellers and buyers often become fixated on adjusted EBITDA when considering due diligence in mergers and acquisitions. However, it remains equally important to understand other financial health indicators of the entity, such as working capital. Inventory and floor plan are some of the most significant items on a balance sheet. Analyzing inventory levels by product line and completing a turnover analysis allows the buyer to detect slow-moving items. Additionally, reviewing for aged inventory can identify future borrowing base issues or the potential of distressed contribution margin on the aged inventory.

Understanding the inventory mix you are acquiring will help you identify issues that could present themselves post-acquisition. Furthermore, identifying adjustments to working capital may help reduce the possibility of money changing hands after the transaction has closed.

Profitability by segment

When evaluating a potential acquisition or sale, an important metric that should be analyzed is profitability by revenue segment. Appropriate segregation of costs provides buyers and sellers insight into the profitability drivers of the entity. These costs often are not easy to identify retroactively, so it’s important an effort be made ahead of the potential sale to provide more detailed insights into what makes the entity profitable. Furthermore, any insight a seller may be able to provide regarding historical profitability trends reduces the risk of a potential issue stalling the deal.

Capacity for growth

Along with financial factors, it is important for a buyer to understand what the target company is capable of in the future and additional costs that may be necessary for planned growth. The target may be operating near or at capacity in the facility it’s currently leasing. A buyer’s integration or growth plans could be significantly hindered by unforeseen capital expenditures not identified in the diligence phase.

Dive Deeper: Visit EideBailly.com to read more about preparing for potential merger and acquisition activity.