Last year, the acquisition of a Long Island company came to a grinding halt — following the surveillance of its CEO.
“We uncovered that he would go at night into the city and buy street drugs,” said Efrat Cohen, executive director of Boca Raton-based Global Intelligence Consultants, which had trailed the CEO for a client who had considered acquiring his firm.
While following a top executive may seem excessive, there’s no such thing as overdoing due diligence before buying a business, say consultants and those who have bought and sold Long Island companies. At the very least, hire a lawyer and an accountant to help you decide if a firm is genuinely viable and its price tag is justified, they say.
Horror stories abound about buyers discovering too late that the business is saddled with municipal fees, burdened by employees’ numerous accrued vacation days, or bereft of valid customers.
“Any seller is going to spin it as positively as they possibly can,” said Michael Wiley, president of Melville-based Healthcare Management & Consulting Services Inc.
And these days, with an ever-growing number of businesses on the market and changing hands, there are plenty of opportunities for buyers to fall prey to a seller’s lack of transparency.
According to BizBuySell.com, a business-for-sale marketplace, the New York metro area, including Long Island, New York City and northern New Jersey, experienced a 20 percent jump in companies for sale, from 4,715 in the first quarter of 2011 to 5,680 in the first quarter of 2016. The number of businesses sold grew 12 percent, from 120 in the first quarter of 2011 to 134 during the same period this year.
The Long Island Association’s chief economist, John Rizzo, ascribes the uptick in business listings and deals to the economic recovery, which has given more people the confidence to purchase a business while improving their access to financing. To a lesser extent, demographics are also at play, he said, with baby boomers increasingly looking to sell their businesses in order to retire.
To minimize post-acquisition bombshells, buyers need to review financial statements and corporate tax returns, as well as delve into areas that could hurt a firm’s future, such as online reviews and relationships with suppliers, experts say.
They also need to review invoices to get a handle on how many customers patronize the business regularly, versus for a one-time project.
“There’s no substitute for buyers speaking to customers directly,” said Chris Nemeth, director and co-team leader of mergers and acquisition services at Crowe Horwath LLP, an accounting and consulting firm in Chicago.
Experts also advise checking the status and terms of a seller’s commercial leases and whether landlords will reassign them to the new owner. Those who seek to purchase a retail store should know if existing leases prohibit the landlord from renting out nearby spaces to similar businesses.
And since a newly acquired business tends to get off to a strong start if key employees remain with the company, buyers need to ascertain these workers’ future plans and whether restrictive covenants are in place to prevent them from starting a competitive operation, Wiley said. He also suggests looking into whether suppliers will hold their prices for the new owner.
Tom Scarda, a franchise consultant with FranChoice in Wantagh, said the Federal Trade Commission requires franchisers to provide a document that discloses a myriad of facts about the operation, including any litigation against or initiated by the parent company and a list of shuttered franchises. But, he said, it still behooves prospective franchisees to talk to existing owners about the kind of training, startup and ongoing support they receive.
With that in mind, Steve Berlin, 53, and his wife, Stephanie, 51, hardly jumped feet first into buying a Sky Zone Trampoline Park franchise in 2012.
A CPA who had worked as a chief financial officer for a media company, Steve Berlin scrutinized the company’s sales materials and legal documents, including independently researched statistics it provided on trampoline injuries, and the firm’s approach to risk management.
The Dix Hills resident’s due-diligence efforts also entailed contacting existing franchise owners; visiting a half-dozen Sky Zone parks to speak with general managers and employees and gauge the customer experience; and traveling to competing parks.
As a result, Berlin today operates Sky Zones in Deer Park and Mount Sinai, employs more than 250 workers and seeks to expand into Nassau County.
Due diligence, on the other hand, led Dan Galvez, 42, to nix mergers with two different companies when he set out to add digital marketing to his Web development company’s services. One firm’s profit margins were too slim to justify an acquisition that would have retained its management team, and “the high compensation requirements” of the other company’s owner could not be supported after the merger, he said.
So Galvez, CEO of Hedgehog Development LLC, a 9-year-old Holbrook firm with five locations and more than 70 employees, approached Loewy Design. Over the years, Hedgehog had partnered on various projects with the Melville business.
“We had a good relationship with them, and knew each other’s culture, business values and teams,” Galvez said.
But before acquiring Loewy, a 29-year-old firm with 13 employees, Galvez tapped Protegrity Advisors, a mergers and acquisitions consultant in Ronkonkoma, for due diligence.
What’s more, the landlord that owned Loewy’s space did its own background checks — on Hedgehog.
“It wanted to make sure the new company has the same level of responsibility” in meeting its lease obligations, Galvez said.