For the past few months, we have been discussing the questions companies should consider when initially considering a joint venture or merger (see Part 1, Part 2, and Part 3). In our final installment of this series, we will go over what questions will help determine the financial health of a prospective business partner’s company.
Before taking the deep dive into a commitment of time and resources needed to pursue a merger, executives on both sides of the deal should be examining each company’s financial statements to ensure the transaction makes sense and will be profitable. With these documents in hand, be sure to ask the following questions:
- Are they showing a profit?
This is one of the most basic, yet essential, questions that should be asked when interviewing a prospective business partner. If they are not showing a profit, what are the steps they are taking to get there? How long will it take?
- Is there anything obviously wrong with their balance sheet?
A company’s balance sheet can tell you a lot about how they are running their business. First and foremost, are they keeping a clean book? Are they complying with GAAP? What does their debt level look like in comparison with their total equity? How have previous audits looked?
- Are there big swings in revenue?
Make sure you are looking for predictable, repeatable revenue and business. Herky-jerky revenue can put a strain on both staffing and cash flow.
- Is customer concentration putting the stream of revenue at risk?
Having large clients is a great thing, but can pose as a risk in the long-term. Not only for their potential to leave, but because of the fixed costs you assume. Make sure you are asking if a small number of clients makes up a big part of gross profits for the company.
- How much bank debt and tax liens or agreements are in place?
When acquiring or merging with another company, it is important to be aware of the liabilities you will be incurring. In addition to reviewing the balance sheet, have your prospective business partner compile a list of their debt obligations so you know which assets are secured against them. Among other things, this could impact your ability to obtain further funding in the future.
- What is their pricing strategy?
Is the prospective partner’s pricing strategy compatible with yours? Are they a cost player or a quality player?
At the end of the day, it is important to take a bird’s eye view of how the potential merger or joint venture will impact both companies. Will the merged company be more profitable than each on their own? Will the company assets be better utilized? Will the end-user walk away with a better product or service?
There is a lot to consider when entering into a business combination. Thinking through the alignment of character and philosophy, products and market, employees, and financial health will ensure you are setting the future business up for success. Once you are ready to dig deeper, check out our Due Diligence Checklist and Structure of Asset or Stock Purchase resources for more information.
ABOUT THE AUTHOR – STUART GUTWEIN
Stuart Gutwein is co-founder and attorney at Gutwein Law. His career encompasses over a decade of experience in several areas of business including mergers and acquisitions, business formation, and product development. He currently serves on the Indiana Business Law Survey Commission, serves as a board member of M25 Group and is an active member of the Ag Law Council of the Indiana State Bar Association.