Due Diligence Case Study - Point of Change Challenges
Located in the Midwestern United States, with an international footprint, the target Company manufactured infrastructure components. The Company produced high-quality, technologically advanced infrastructure components for a host of applications with a diverse customer portfolio.
The Company’s two shareholders were also the Company’s founders. In the eleven years since its founding, the Company grew to be an industry leader providing innovative engineering as well as construction assistance. As a value-added manufacturer, the Company positioned itself as a critical partner of the customer and the project contractor.
The shareholders were seeking equity investors to raise the capital needed to take the Company to the next level. The Company was at a point of inflection poised to step up from $14MM in annual revenues to over $28MM. Both owners wanted to stay on with the Company in a strategically significant capacity; albeit, one owner was nearing retirement age. The Company also had a highly qualified human resource bench for mid-level manufacturing management.
While highly qualified engineers, the Company lacked the administrative capacity and financial acumen to meet the operational and business requirements of a mid-size company. Areas that presented due diligence challenges and constrained the Company’s growth and profitability included:
Manufacturing Facilities. The Company had grown piecemeal without the strategic planning necessary to accommodate long-term growth. The Company’s manufacturing facilities were fragmented between four facilities in close proximity, but entirely disjointed. The result was dramatic resource inefficiency and an inability to meet production demands. Plans were in place to adapt operations to accommodate the existing properties at the cost of productivity.
To complicate the situation, the facilities were potentially contaminated with ground contamination as well as potential vapor intrusion to neighboring properties. One facility was located in a residential neighborhood. The pervasiveness of the volatile hazard was apparent half of a block away. Atmospheric conditions within the facilities were intolerable.
Human Resources. The manufacturing process relied on experienced labor with post-secondary engineering education and two years of practical experience. The Company human resource capacity was limited to management interviews of available candidates and informal advancement / accountability. The Company lacked a program to recruit, train and promote entry level production staff to mid-level supervisory management. Consequently, the Company was not positioned to promote mid-level management to senior management positions where their expertise was needed to meet growth demands and replace the soon-to-retire owner.
Accounting and Finance. The Company’s accounting records were maintained on QuickBooks with no MRP system in place. This severely restricted the Company’s ability to develop actionable metrics to support project bidding, production, and strategic growth. The Company’s accounting department was well versed at managing accounts payable, receivables, and preparing payroll, but lacked the acuity to provide advanced accounting. The Company engaged a CPA firm to prepare its income tax returns, however, the Company’s financial records were not reviewed or audited.
Facility Consolidation. LAC performed a search of properties that would meet the Company’s manufacturing requirements in a locale that was economically advantageous and kept the Company near the owners. Our team of accountants prepared projections for CAPEX requirements with ROI analysis incorporating financing options, ownership versus long-term leasing, realizable production efficiencies, and tax considerations. A preliminary strategic plan for moving the facilities was prepared to minimize manufacturing disruptions and ensure on-time project delivery.
Environmental Conditions. To protect against successor liability and improve the working conditions in the manufacturing facilities, it was necessary to determine with certainty what, if any, environment issues existed. LAC engaged an environmental consultant to perform Phase I site assessments of the facilities. Through LAC’s network, we engaged a highly qualified team of professional on a confidential basis. The team performed its duties with tact and appropriate covertness to guard against unintended consequences.
Human Resources. LAC, in its decades long history of taking companies to the next level, has partnered with a select few human resource service providers. After consulting with our operating partners, we engaged a professional employer organization (PEO). The PEO provided us with a carefully prepared plan to leverage the Company’s industry leadership to recruit the best and brightest engineers from prominent universities. We formulated a strategy with key milestones and benchmarks to prime the pipeline with human resource capital. We also earmarked 8% of the equity in NEWCO for compensation of key employees – a deciding consideration for the seller, who remained loyal to their long-term employees.
Accounting and Finance. First, we needed to ascertain the profitability of the Company based on generally accepted accounting standards. Accordingly, we performed a review of the accounting records and made the necessary adjustments for material discrepancies. We then compared the results to industry benchmarks for like-sized companies.
Because the Company had not prepared forward-looking financial statements, we reviewed the Company’s recent history, order backlog, and open bids, combined with industry / market projections. From this extensive work, as well as the work performed projecting CAPEX outlays, we prepared present value proforma financial statements, breakeven analysis, and ROI projections.
The Company presented significant due diligence challenges that LAC overcame by applying its expertise and network of resources. As a result, the Company was fundable at a much lower cost to the sellers and equity investors.
Our exhaustive investigative work to uncover potential environmental conditions combined with our network of legal M&A advisors avoided what may otherwise have been a blackhole of successor liability. A single facility to accommodate all current manufacturing with the space and layout to provide for second and third shift capacity was sourced. Environmental concerns were determined to be manageable and the Company was positioned for a long-term gain on real property transactions.
The Company allayed the uncertainty of its prized mid-level managers related to the sale of the Company. The Company successfully demonstrated its commitment to its employees through a formal structure of success based compensation and advancement. The Company had in place the foundation for providing recruits with highly attractive, world-class career opportunities. Costs associated with staff turnover were significantly reduced and the Company enjoys a stable, highly qualified work force that is scalable to growth.
The re-stated financial statements accurately presented the Company’s position and operating results. The beneficial results allowed us to provide the seller with an attractive offer, structured to ensure their non-monetary considerations were fully realized. The Company is successfully growing and continues to operate in its city of origin with the founders at the helm.
Despite significant progress by all parties during the due diligence, LAC could not eliminate the risks associated with the environmental challenges. Despite our ability to move to a greenfield facility – the historical contaminates could not be mitigate enough to justify our investment