War Story: Look Out For Smoke & Mirrors

As a business buying culture, we are very aligned with growth by acquisition. However, are there times when this growth path can cause issues for buyers?

One of my clients needed a Quality of Earnings on a 20-year legacy business. In the previous 18 months, the company had acquired another business. According to the owner, this acquisition was aimed at “entering a new industry vertical.” In our opinion, the new area of business did make sense for the company.

During our QoE process, we generally analyze revenue and profit growth (or decline) in each segment of the business. And, yikes! The core, 20-year-old business was in decline. This wasn’t initially obvious as both the revenue and profit for the company as a whole were positive. The growth in the newly acquired business was covering for the decline in the core business. So who cares?

In this case, the two to three years of declining revenue and profit in the core business made up about 70% of the business’s overall revenue. It was a falling knife. Only 30% of revenue represented over 80% of the profit. You’d never buy this company. My buyer would have loved to make the deal the seller made 18 months ago, but the combined business was now very complex.

We asked the seller question after question about what was driving the decline. We wanted to find out if the new acquisition was truly synergistic or if it was a way to bail out the original company that was already in decline. The seller didn’t give us any insight. Sellers often refuse to answer questions that shed a negative light on their companies.

At the end of the day, I recommend the client re-trade the deal based on what we knew now. The seller didn’t like it and put the deal on pause. Soon after that, the stories of the recession began, and the seller wanted the deal back. By then, the buyer was spooked.

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