Every year people invest their hard earned money to become a first time business owner. In effort to grow revenue or market-share, successful businesses try to acquire others with the hope of expanding their geographic reach or to become larger players with in their industries.
Whenever one company acquires another, it takes on the good, the bad and the ugly. If the target business is burdened with debt, plagued by disorganized financial records, engrossed in costly lawsuits or insurance claims — all these issues become the new company’s problems to deal with.
The benefits from acquisitions are often outweighed when the acquiring company also gains unexpected liabilities.
I once served as risk control and safety professional for a regional fitness-based business that operated 36 locations in seven states. It attracted the attention of their largest competitor for an acquisition. While they were in discussions it became known that a class action lawsuit had been filed, which immediately devalued the business, forcing the lender to call in their loan and compelling the owner to settle on a much lower value — rumored to be more than $100 million less than originally valued.
A great deal of investigative work goes into determining the true value of the business as well as any and all liabilities. Many business owners will look to acquire a business that is geographically convenient.
A company with a clean financial statement and reasonable debt at a high interest rate that a larger business could refinance for much less is a prime acquisition candidate. Any unusually high liabilities, however should send up a red flag to potential investors.
Profitable businesses try to acquire other businesses that have a clean operating history, with a consistent revenue stream, avoiding costly history such as prior bankruptcies, erratic earning results, or the loss of a major customer.
While most businesses face a lawsuit once in a while – gigantic companies such as Wal-Mart are sued several times daily – a good acquisition candidate is one that isn’t dealing with a level of litigation that surpasses what is reasonable and normal for its industry and size.
Before making an acquisition, it is imperative for a company to evaluate whether if the targeted business is a good candidate by completing a Due Diligence review.
In addition to the examination of the books, the buyer should also complete a Pre-Acquisition Risk Management Safety Audit to help prevent any unwanted surprises. A comprehensive appraisal of coverages and limits of liabilities of the key commercial insurance policies of the target business and past loss history should be complete on the following: Workers Compensation, General Liabilities, Auto Insurance, Umbrella /Excess, Products Liabilities, Employment Practices, Directors & Officers & Errors & Omissions.
Larger companies will employ the use of a law firm or merger/acquisition advisors and consultants while smaller business owners will work with their bank, attorney and sometimes their commercial insurance agent. If the insurance agent is worth their weight as a trusted advisor, they should be willing to handle this phase of the due diligence with the hopes to acquire this new business.
The ultimate purpose of Pre-Acquisition Risk Management/Safety Audit is to identify any potential deal-breakers. You should review the following:
— Outstanding Lawsuits: If there are any lawsuits outstanding against the targeted company, ascertain their status. If there were any prior lawsuits within the past five years that were settled, obtain copies of the settlement agreements. Prior lawsuits also can identify a pattern of exposure.
— OSHA: Complete a company search on OSHA’s website for prior or current citations and penalties. If the targeted company has prior citations that have yet to be settled by OSHA, you could be on the hook for penalties. If therecitations within the last few years that were not adequately corrected, then you are subject to some very expensive willful penalties if ever re-inspected by OSHA.
— Loss Runs: Request prior property, general liability, auto and workers compensation loss runs to determine if the company losses are trending up or down. You can also request and OSHA 300 logs to review employee injuries to determine loss trends. Does the business suffer from an inordinately high proportion of incidents and appear to be excessive? What is the employee incident rate compared to others in that industry?
— Experience Mod: The experience modifier indicates the degree severity and frequency of workers compensation injuries and anything above 1.0 indicates that this business is worse than the average. Anything less than a 1.0 is better than average.
— Review of New Operations: Often the business being acquired may have taken on a new operation or altered their operation. An example of this is when a manufacturer stops purchasing pallets and began manufacturing and storing their own, increasing the exposure for a total fire loss and or amputations. Sometimes these exposure changes may not be covered under their policy, if they didn’t inform their insurance carrier.
— Exposure Controls: A risk control safety professional should be hired to review the operations to determine if all the proper controls are in place to minimize future losses. A thorough review of all the safety programs, equipment, machinery, guarding, property protection, proper personal protective equipment, proper ventilation, management controls …etc. should be completed. He or she can also estimate the cost of adding any needed safety equipment, personnel, procedures, or training which could be used as leverage on the final purchase price.
— Property Controls: Is the sprinkler system adequately designed for the occupancy? Often times a company will relocate into a new building, but the sprinkler system is not designed for their occupancy, potentially making the fire load too high for the current system. This also occurs when additions are added on to a building, where the general contractor (GC) doesn’t build it for its intended use. For instance if the GC is told that the storage height is only going to be 10ft, but the occupant later raises the height to 18 feet, this is now a potential costly exposure.
— Fleet Controls: If the targeted business has a commercial fleet regulated by D.O.T you should review its Safer Scores from the Federal Motor Carrier Safety Administration. Their driver selection process, policies, preventative maintenance schedule, driver files, age of vehicles, etc., should also be reviewed.
— Product Liability: If you are acquiring a manufacturer you will want to investigate the ability to recall that product, their tracking system, warranties and the lifespan of the product. If for instance the targeted business is fairly new, you should expect to see an increase in product liability claims as that product begins to age. Is there a discontinued product that could come back to cause you to be named in future lawsuits?
— Employment Practices: Are there pending discrimination, harassment, wrongful termination claims? Has there been a history of such claims in the past? If so, are the claims related to a specific person, or are they spread across the management team?
— Gaps, Hidden or Underinsured Liabilities: Your insurance agent should thoroughly review the operations, looking for misclassifications on the insurance policy, underinsured limits of liabilities and gaps of coverage.
— Inventory Controls: The business shrinkage control should be carefully evaluated with a keen eye for fraudulent activity, especially if it’s a cash operation or they store high valued products. Great detail should go into evaluating their work practices, proper layers of physical security controls, and dual and redundancy controls to prevent and detect theft.
— Disaster Recovery Plan: Is there a disaster recovery plan in place that states how the targeted business will address a disaster if it was to ever strike? Have they identified all bottleneck within their operation, key suppliers, key personnel, formed other alliance with competitors if there were a disaster to strike businesses? Do they have backup plan for information?
— Claims Review: All outstanding large loss claims should be reviewed by a competent claims professional, reviewing the status of any open claims to see if these claims are adequately adjusted with the proper reserves, and if any of these claims can quickly be settled or closed out prior to the purchase. The worst case scenario would be to have a large loss reopened or adjusted at a much higher value which would negatively increase future insurance rates.
In conclusion, there are many areas where a Pre-Acquisition Risk Management Safety Audit becomes a necessary decision-making tool. Building these potential costs into financial models at the due diligence stage should eliminate any nasty surprises when placing the insurance coverage between exchange and completion.
Be Safe My Friends.
Keven Moore works in risk management services. He has a bachelor’s degree from University of Kentucky, a master’s from Eastern Kentucky University and 25-plus years of experience in the safety and insurance profession. He lives in Lexington with his family and works out of both Lexington and Northern Kentucky. Keven can be reached at kmoore@roeding.com.