Issues Before and After Acquiring a Business

Jamie Windle:

M and A is happening where you don't see it actually happening. So we're seeing a lot of consolidation or what we call roll up opportunities. Where an investor will pick a certain industry and decide to roll up that industry. And where we're seeing a lot of that is in, let's call it the broader healthcare providers.

Narrator:

Welcome to Accounting for the Future, A BDO Canada podcast for financial leaders to navigate change and achieve business growth. We'll uncover the challenges financial leaders may not have dealt with yesterday, but will definitely have to manage for the future.

Armand Capisciolto:

Hello and welcome to Accounting for the Future. I am your host, Armand Capisciolto, BDO Canada's National Accounting Standards partner and Leader of Accounting Advisory Services.

On today's episode, I'm joined by two BDO partners. Jamie Wendell, a partner in our Transaction Advisory Services Group, who specializes in financial due diligence. And Ziad Akkaoui, a partner in our Risk Advisory Services Practice. Today we're going to discuss what companies should consider before and after they acquire a business. Jamie and Ziad, welcome to Accounting for the Future.

Jamie Windle:

Thanks, Armand, happy to be here. Looking forward to talking about this topic.

Ziad Akkaoui:

Likewise.

Armand Capisciolto:

So, Jamie, according to The Globe and Mail, an article I recently read, Canadian companies are involved in a record 350 US dollars, 350 billion of M and A activity last year. That seems like a big number. Did you see that last year in the work you're doing?

Jamie Windle:

Yes, Armand, absolutely. The market has been this busy. I would say broadly speaking, since the beginning of COVID, we have really seen a real explosion of the M and A world. And I think there's two main issues that are sort of factoring into why this has happened.

And the first is on the, let's call it the demand side. If we think about the private capital that is in the, and let's just talk about the North American M and A market these days, that number, you thought the 350 billion was big. The last number I heard is that there's 2.9 trillion US of dry powder in the market.

And so, what does dry powder mean? That's effectively, this is cash that investors are looking to invest into the North American market space. So, there is a large, large, large demand for taking companies. Either taking them private or buying already private companies and doing something else with them. So that's on the demand side.

On the supply side, thinking about more companies that are in market today and looking to sell, COVID has been a sort of an indication that there are a lot of baby boomers that own businesses in the mid-market economy that we are in. And effectively what I've been hearing and what I've been seeing, is that these baby boomers, these baby boomer owners and entrepreneurs that are in the market today, don't want to go through another ordeal that we just went through for the last two years.

They have decided that time is ... Enough is enough. We don't have another crisis in us to want to have to weed our way through and figure out how to get through it. So, I think that's pushed up what would've happened already in the marketplace from a baby boom generation of having to retire out of their businesses. This is pushing that up a little bit faster than what we would've otherwise expected just due to demographics in the marketplace. So, I think it's a combination of demand and a combination of supply in the marketplace.

Armand Capisciolto:

It's so interesting that the not wanting to go through another COVID type scenario. And hopefully, I don't think any of us want to go through another COVID. We really want this whole ordeal to end. But when I look at that statement, it's really interesting because in addition to COVID, we're dealing with some really uncertain times right now.

You got the lingering effects of COVID and the impact that has on supply chain. You have the geopolitical issues that Russia and Ukraine impacting supply chains, impacting markets. We have inflation. We have rising interest rates. And these are all things that I would look at and say, "Wow, that creates a lot of uncertainty."

Would someone want to buy a company in this very uncertain market? But it's interesting because what you're saying is that might actually lead more companies wanting to exit because they don't want to deal with this uncertainty. And is that actually creating some good buying opportunities for companies buying because of where valuations are and that sort of impact?

Jamie Windle:

I think it's a combination of both. I think if we think about, yeah, there's a lot going on the global economy and this global world we live in right now. But if you think about these entrepreneurs and these business owners today that are thinking about selling, these are all individuals who may have started their careers in the '80s. And if you think about the last 40 years, this is just another blip in what they've gone through the '80s, '90s and 2000s, and all the things that they went through.

And I'll be honest, and one example I can give is I had a client who effectively told his wife that he would give her 10 good years of retirement and he was already 75. And he basically said, "It's no more. I need to do it now. I need to get out. Even though I'd like to stay and do this longer, it's time to give her what she wants and stay longer." And all these sorts of crisis's that we're going through, just convinced him that I don't know if I can make that, or keep that promise of 10 years, given where everything is going these days.

So, I think that's providing a lot of opportunity. In terms of regardless of current pricing in the marketplace, pricing has been very high, I would say to be conservative. Very high over the last two and a half years, especially if you are in the IT space.

Armand Capisciolto:

Yeah, so even though the prices have come down, they're coming down from very, very high valuations. So, they're relatively speaking, in the grand scheme of things, when you're looking at a company and looking at an organization that's been around for 30, 40 years, it's still high, right?

Jamie Windle:

It's still high. Exactly. Exactly.

Armand Capisciolto:

And so, what are you seeing so far this year? Is the trend continuing? Is even with this uncertainty, there's still quite a bit of M and A activity happening?

Jamie Windle:

The M and A market are still very, very busy. And really where we're seeing that, and I think this'll be really interesting for a lot of listeners out there, is that M and A is happening where you don't see it actually happening. So, we're seeing a lot of consolidation, or what we call roll up opportunities. Where an investor will pick a certain industry and decide to roll up that industry.

And where we're seeing a lot of that is in, let's call it the broader healthcare providers. So, we're seeing roll up opportunities, well not opportunities, the opportunities are being created because there's investors who see opportunity here. In the dentist office, in occupational therapy, in home healthcare, in the veterinarian space. And I realize veterinarian may not fit into the classic definition of healthcare, but just a little bit different type of healthcare. And the specialty doctor space. We're seeing a lot of seeing lot roll-ups in those spaces from a healthcare perspective.

And then from a broader perspective, we're seeing a lot of it in insurance brokerages, HVAC, car washes, high-end real estate brokerages. We're seeing roll-ups in this everywhere we look, these days it's happening. And the average person may not see that on the street because they're not necessarily changing company names, or sorry, the brand name that they're going to market with. But in the back office it certainly has changed and will continue to do so.

Armand Capisciolto:

It's really interesting even from a, we're actually working with a client right now that's in the vet business that is part of that consolidation. And we're dealing with how do they consolidate all of these individual vet clinics into a consolidated group?

And it's interesting today, even just today, personal story, I went to pick up my glasses at my optometrist. The glasses I'm wearing that our listeners can't see. And walk into the optometrist and it's no longer, you don't see it. The name on the building is still the same, but the name on the credit card receipt is different. And the products they do is different. And I very much recognize the name and know that yes, they have obviously in the past little while been acquired, but in one of these organizations.

So, we are seeing this in our everyday life. We're seeing it in clients. The one that when you were listing it out, the one that made me kind of ... Car washes, I just found that one interesting. Wasn't something I was expecting you to say today, Jamie, was consolidation of car wash is such an interesting one.

Jamie Windle:

Yeah, it's really anything that, and going back to a personal story. I was walking with; I had a coffee with an investor this morning. And they basically said that if we can buy of relatively small companies five, 10, 15 and merge them all together, there are bigger players out in the market that they can then sell that combined entity to the bigger, bigger players that are doing the same thing at a bigger, bigger pace.

Armand Capisciolto:

Wow. Really, really interesting market right now. As both of you know, my day job, I get excited about accounting issues. And so, I'm going to start off, I'm going to ask an accounting question, but not really an accounting question.

But one of the areas that I see a lot of issues with when any acquisition happens, is earn out arrangements, contingent consideration, whatever you want to call it. So, situations where obviously part of the purchase price is contingent on the performance of the company after the fact. And I've been involved in litigation support related to those types of transactions, see them as an auditor, see them as an accounting advisor in accounting for these things.

And it's one of the things I've often wondered is when a company is doing its due diligence on an acquisition, when they're negotiating the agreement, is that something that you spend a lot of time looking at and saying, "Okay, if you're going to structure the deal this way, here's some consideration in setting the earn out amount." What does that process entail?

Jamie Windle:

Yeah, that's a good question and we are seeing a lot of that. And if we think about, just to be a little bit broader here from that perspective, here in Canada, we've got the two different accounting policies, for lack of a better word. The ways that we calculate what are the proper policies that a firm or a company should be following? And that's the accounting standards for private enterprises, which is effectively a GAAP for smaller, mid-market Canadian practices.

And then there's those companies that are dealing on a bit bigger basis, which is IFRS, which is International Financial Reporting Standards, which by definition are international in nature. So generally accounting firms, or sorry, not accounting firms, generally our clients and the targets that we're looking at, are either doing one of those two. Or alternatively they're doing a third and that third is whatever they want, which is effectively cash accounting. The money comes in, you record it as revenue, and they don't really pay too much attention to the accounting standards that go behind it.

But depending on where the buyer is coming from, and this is where it's going to throw another little loop in there, is US GAAP. And we see a lot of buyers that are Americans that are following US GAAP. And so, it's absolutely something that buyers and sellers need to be aware of and need to be thinking about of how this impacts the numbers going forward.

Armand Capisciolto:

Yeah, it's really interesting. And, Jamie, I know we've worked together on some of these where you're dealing with the due diligence and you're looking at quality of earnings. And you have this US buyer who's saying, "What's this ASPE thing?" Accounting Standards for Private Enterprises in Canada. "And how is the revenue different from US GAAP?"

And even when I think about the carwash example, I would think most car washes, an individual carwash is probably not following any GAAP. They're getting probably a notice to reader type of financial statements, cash visas of accounting. And then someone acquiring them who's saying, "Well earnings matter, I need to know what the quality of my earnings is going forward." That's a change, right. And that's something that when you're buying a company and you're reading their financial things, knowing what GAAP they're applying is important.

Jamie Windle:

That's why it's important to do your diligence.

Armand Capisciolto:

Yes. And it's really interesting, we actually from the other side, the seller side of it, not that we're not talking about that today. We've recently done a publication on choosing the right GAAP. And basically focusing, getting companies to focus on what is your end goal? What are you doing? And if your end goal is to sell, are you thinking about the GAAP that the buyer is going to want?

And that will actually also be a future podcast episode for us as well. So, for those of you that are listening in and want more on choosing the right GAAP, please, please stay tuned for that.

So, thanks, thanks, thanks for amusing me with accounting questions, Jamie. I know I get excited about these things. But before I turn over to Ziad, I guess the other thing, I want to turn it to you and to your expertise. And really what are the top two issues that you feel companies overlook before they buy a company?

Jamie Windle:

Yeah, that's a good question. So, everyone wants to know from a standard perspective, everyone wants to know what are the earnings that I'm getting? And so that's the number one thing that everyone looks at.

The other two places that I think are important, and that sometimes get fallen behind or forgotten about, is one, who are the people that you are acquiring that's part of this deal? The management team or the current owners of the business that may be staying on in the business post transaction close.

And the reason why I say that, in this day and age of social media, it's very easy to get yourself connected with people of, for lack of a better word, disrepute. And what we effectively tell our clients is, "You're doing all this diligence to understand the earnings, let's make sure you do some diligence to make sure these are the people that you want to be investing in. And that someday down the road, they're not going to embarrass you with something in their history that gets splashed all over social media, that's now connected with your name." So, I'd say that's number one.

Armand Capisciolto:

Very good advice for that to be considered, especially in today's day and age.

Jamie Windle:

Yeah. And then number two, the other side of it is from a tax perspective and making sure that investors and sellers know what the tax situation is. And here in Canada we have something called Canadian Controlled Private Enterprises. And effectively there are some tax incentives of how you sell that business.

And so, a lot of buyers want to buy only the assets coming out of that business. They don't want your legal enterprise. They don't want the company itself because they don't want all the bad things that's associated with it, lawsuits or tax situations. But there are big, big tax benefits if the seller actually sells the company itself, the shares.

And we see on more times than I care to admit, where sellers effectively decide at the last minute that they don't want to sell just the assets of the business. They've been given advice far, far down the road from their tax accounts that says, "No, you need to sell the actual company, the shares because of the big tax benefits of doing it that way. Or that these things, selling it that way versus assets means cash in your pocket."

Armand Capisciolto:

Yeah, and it's interesting because I get to see a lot of purchase and sale agreements after the fact. And see a lot of purchases of shares and we'd often see kind of indemnification clauses in those agreements, especially related to tax issues. But the good agreements, in my opinion, are the ones that actually they're known issues that they're getting indemnification. But the only way to know those issues is to do your tax due diligence. Right?

Jamie Windle:

Exactly. Exactly.

Armand Capisciolto:

Okay, very interesting. Thanks, Jamie. So, Ziad, you're a risk advisory partner. So, you get involved after the deal is done and as companies are trying to integrate processes, controls, and bringing everything together.

So, before we talk about after the deal, I think the first question I wanted to ask you is what is something that you think companies should think about before the deal that causes you a lot of headaches after the deal when you're helping a client integrate?

Ziad Akkaoui:

That's a really good question, Armand. I would tell you that we've come across this issue over the last little while. And one of the biggest things that we've noticed is that the integration of two operational cultures together and discussing logistics around change management, is something that gets overlooked.

So, while the business model may be in sync with one another, how do you ensure that the people, the processes, the technology, everything that's really behind it, also will fit? And a lot of times the buyer might have sophisticated processes in place. They've got defined policies, procedures, somewhat of a mature control environment. Whereas on the other side, you've got the business owner that just sold his business. That's likely more entrepreneurial in nature, more action focused, less so on processes.

So, there could be a significant difference in the operating environments that the acquired company may need to adapt to. So, I would tell you that in this case, finding a common middle ground early on in the transaction, on how the two companies will integrate culturally as well as a lot of the other elements that come along with it is really necessary at the onset of the acquisition.

Armand Capisciolto:

Yeah, it's really interesting. And it's interesting you bring up culture and Jamie brought up people as well because culture is about people. So, it's really interesting that the two are very aligned. And you bring up the mature company versus the entrepreneurial company because that's one of the trends we're seeing a lot in our practice as well. Is mature companies buying less mature companies, especially where any technology's involved, right.

You have a mature company wanting to evolve and rather developing technologies themselves, they might be acquiring companies that bring that technology to the table. So, when you have that situation and the mature company is used to that rigor of internal controls and the processes and all that, how do you bring that together? How do you bring this entrepreneurial company in, put a bunch of controls and processes over them, and still maintain that entrepreneurial spirit that was critical to the acquisition?

Ziad Akkaoui:

Yeah, that's exactly it. And I think it's really important that when the deal is happening, that the business owner that's getting acquired is having frank conversations with their respective teams. To discuss some of the change management issues, especially around operational processes because change is going to be required regardless.

When you take a look at the differences in the size and scale of the buyer versus the business owner, they sometimes won't be conducive to accommodate changes in processes and controls. So, laying out a lot of the foundational work upfront in terms of we expect to see changes around financial processes. The technology stack that the business owner might have in some cases might be either developed in-house, it might not be as mature as the company that's making the acquisition. So, trying to lay out some of that foundational work is going to be necessary. And then at that point, it's really about socializing what are the top priorities from a change perspective?

So, when we take a look at segregation of duties, in a smaller organization, it's really difficult to achieve segregation of duties because you have in a lot of cases the same one or two individuals performing a lot of the finance functions. So, sort of rethinking, reconfiguring roles and responsibilities will need to be required upfront. Obviously, you've got a more sophisticated finance team that you'll be able to integrate with that will be able to address some of these issues. And it's also important to make sure that the acquired company is aware of what are some of the new task's controls that are expected of them? And gradually building up some of the capabilities internally.

Armand Capisciolto:

So, it is possible to still have, bring in an innovative company to still have controls and maintain that innovative environment.

Ziad Akkaoui:

It absolutely is. And there's always an adaptation period, a transition period. You can't expect on day one to walk in and expect all of the operational processes to have matured and adapted to the larger organization. So, it's one of those things where it's important to prioritize what's ahead of you.

And I don't want to necessarily throw this conversation off, but what also makes it really interesting is that if the acquirer is a public company, then the business owner has new requirements and complexities that they need to deal with around regulatory compliance. And it's something that's obviously very new for this type of organization.

So, the integration of the business, thinking about the acquirer has requirements to certify on internal controls and disclosures, and you eventually need to integrate the new business into that model. There are transitional periods that are provided, and that's why I'm saying you have to create a specific transition plan. But definitely any innovative organization could continue to operate the way they are, but they definitely need to prioritize these types of changes.

Armand Capisciolto:

It's interesting you bring up the whole public company scenario because forget an acquire/acquiree scenario, even when we see companies go public, that transition from being a private company to a public company is a big one. And there's the securities regulation. But for me, the big thing is that I always tell clients is like, "You're not playing with your money anymore. You're playing with someone else's money. And when you're playing with someone else's money, there's a higher standard that you're placed under."

And the same thing happens to that acquiree company that gets purchased by the public company. You're now in a different world and it's different. It is what it is, and sometimes it's hard for the individuals involved to be ready for that.

Ziad Akkaoui:

Absolutely. And at the end of the day, if you are a public company, you've got a lot of really strong mechanisms internally. You've got fairly mature policies and procedures that can easily be shared and adapted with the acquiree. So, you're not starting from scratch, and you've got support from the acquirer on trying to adapt to their operational processes. So, the transition should be smoother that way.

Armand Capisciolto:

Okay. So similar question to what I asked Jamie. When you think about the work you do with clients. And what are the two or three top issues that you thought that you would think or want clients or organizations to pay more attention to after a deal? What should be their priorities?

Ziad Akkaoui:

Yeah. I would tell you that beyond just culture and change management, it's also looking at some of the operational processes. So, these days, the whole concept of third-party risk management, vendor governance, when you're onboarding and acquiring a business, you're also acquiring a number of contracts that come along with it.

And in most cases, it's very important to understand what are the existing relationships that you have with specific suppliers and service providers? With the emergence of organizations moving to the cloud and their data being in all kinds of different environments, you want to make sure that you wrap your head around how you protect specific information, privacy, confidentiality of data.

So doing your due diligence around third party risk and vendor governance is required upfront. And a lot of organizations overlook that, and I think it's a very big mistake altogether. Because these contracts in most cases are locked in for a long period of time. And in some cases, the IP might actually be owned by one of the service providers, and it just creates complexities in terms of integration. So, it's important to review your technology stack and a lot of your vendor contracts.

Armand Capisciolto:

Okay. Going to end with the question, same question for both of you. A topic I've become quite passionate about is sustainability or ESG, environmental, social, and governance. And companies are going to be, again, public companies will eventually have to report on this as part of their securities filings. Other companies will need to report on this to their customers or financiers.

So, I guess when, Jamie, start with you, is sustainability is ESG climate, is that coming up now as an issue when you're doing due diligence work for companies?

Jamie Windle:

Yeah, Armand, it's starting to. I think I wouldn't necessarily say that Canadians are at the forefront of doing this. I think our European colleagues are much more in the forefront and they're actively doing ESG diligence as they go through to understand what kind of sustainability? What sort of issues that they are looking at with the companies that they're, like European investors are looking at acquiring? We are starting to see that in Canada, but it's very, very nascent, very new.

Armand Capisciolto:

It's the early days, right. And I think as the securities regulation kicks in, as companies start pushing, we're likely going to see more of it. But yeah, it is probably still early days, and the Europeans are quite a bit ahead of the North Americans on this matter.

Ziad, from an internal control standpoint, does this change anything for you now when you think about this new information that's going to be needed for companies to report on sustainability?

Ziad Akkaoui:

It definitely does. I would tell you that one of the biggest challenges that organizations have and will continue to have, is making sure that their systems have the appropriate data points and mechanisms to be able to capture the information that's needed to report on ESG.

It's already sort of a challenge to make sure that you've got the right mechanisms to track a lot of your financial information, but now you're tagging on a lot of other data points that are required to report on ESG. So, when we talk about the concept of internal controls and making sure that they're also capturing processes to measure and track some of that, will be a significant change.

And I truly do believe that internal controls have a major part to play in ESG reporting because the information needs to be verifiable and auditable. And the best way to be able to support that is through internal controls.

Armand Capisciolto:

Well, yeah, and especially when you talked about the public companies, and you mentioned earlier kind of CEO and CFO certification. And in the US, I believe if I'm reading the regulations correctly, this is going to be covered by their actual reporting for the Sarbanes Oxley Act. So, when you think about those things, and it's really becoming critical, the internal controls over this from a public company standpoint.

So, gentlemen, thank you so much. I think we've covered a lot today in a short time. Again, I and our audience really appreciate your time, your expertise that you shared with us. And I'd also like to thank our listeners for tuning in today. I'm Armand Capisciolto, and this has been BDO's Accounting for the Future. Please let us know if you found this topic interesting and useful and remember to subscribe if you liked it. We'll see you next time.