Financial pitfalls of selling to newly acquired companies

. The former company was a partnership or proprietorship, and so is the new business

Since the assets of the owner(s) in a partnership or proprietorship are subject to creditors, knowing the personal financial strength of new ownership is essential to establishing the strength and liquidity of the company.

The company was a partnership or proprietorship, and is now operating as a corporation or limited liabitity company

/-\oveeNIES ARE oN high alert today when it comes to \-, closely watching their trading partners' purchasing patterns and pay habits. The challenging economy and a continued tight lending environment have only served to increase pressure on creditors to be vigilant in looking for warning signs from customers, such as changes in orders or an increase in delinquent pay.

Perhaps the most significant concern is when a longstanding customer is sold to new owners. Immediately, relevant questions leap to mind: Will my current invoices be paid in full and on time? Will the new ownership continue to buy from me in the future?

Of equal significance are details frequently overlooked-the what, who, and how-concerning a change in ownership. What was actually acquired by the new owner(s)? What is the legal structure or formation of the new company? How did the buyers fund the purchase? And, often most importantly, what is the experience and background of the new owner(s)?

The following sections will illustrate how careful, proactive due diligence should uncover the answers to these and other essential questions.

Whatr The legal formation of the company

The first step in determining the legal structure of a newly acquired business-and how different it may be from the original entity-is knowing whether it is a partnership, S or C corporation, proprietorship, or limited liability company. This designation plays a crucial role in understanding the liability of the new owners and, most notably, their personal liability, which can affect the creditworthiness of the company.

The following scenarios illustrate the potential impact of a new owner on a firm's creditworthiness:

If a partnership or proprietorship's assets are purchased and incorporated, most likely, certain personal assets (i.e., a home, retirement accounts, etc.) of the former owner will not be included in the sale. If this is the case, the liability of the new ownership is limited to the actual assets purchased and placed into the corporation. As such, the amount of assets available to creditors will have diminished; knowing which assets were transferred into the new corporation will help determine if the new company's balance sheet is as strong as before the purchase.

. The company operated as a corporation and the purchase included all outstanding capital stock of the organization

In purchasing all capital stock, new ownership acquires all assets and liabilities of the former owners, which are then subject to creditors'rights.

How: Details of the purchase

In addition to understanding the new company's legal structure, it is also advisable to know how the purchase was financed. Some new owners may not publicize details of the acquisition, but this information may have direct impact on the company's creditworthiness going forward. Understanding the new firm's financing will verify any impact it may have on its financial position. Since most companies are corporations, the following illustrations assume the purchase was for the former owner's capital stock:

. New owner(s) bought the company using personal finances

The company itself does not incur any debt and there is no direct impact on its equity position. It should be noted, however, if the new owner obtained personal financing to buy the stock, the lending institution likely would require collateral to be posted against the loan-and business assets are often pledged as collateral.

. New owner(s) borrowed money from a financial institution for the capital stock and will retire the (treasury) stock

The company's balance sheet shows an increase in lia-

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. New owner(s) financed the purchase of capital stock through a note payable to the former owner(s)

A payout agreement is signed, requiring installment payments to the former owner(s). Similar to bank financing, this creates long-term debt affecting the liability section of the balance sheet. With the addition of debt, the overall equity of the company can be impacted.

Keep in mind, with the last two scenarios, adding debt to the company's balance sheet can have an effect on its working capital position as well.

Who: The new ownershipts vision for the company

Another more tangible aspect of an acquisition concerns how new owner(s) will manage and operate the company. When a business changes hands, there is no guarantee the new owners will handle day-to-day operations in the same manner as their predecessors. The following questions need to be answered to determine whether to continue doing business with the company:

. What is new ownership's vision for the company?

Oftentimes, new ownership may look to expand the company's focus to include new product offerings, obtain new customers, or change buying and/or selling strategies. Expanding a product line may be detrimental if the company has no experience in that particular business segment. Adding new customers is generally a focal point of all companies; however, the quality of new accounts may impact you and your business.

For example, if new accounts are slow in paying, it could have a domino effect on how fast you are paid.

What is the background of the new owners?

An essential question to consider prior to continuing your association with an account is the industry-related management experience of the new owners. Consider the following questions about the new ownership when making this determination: x Do they already own an established company within the industry? x Were they a key part of former company's senior management team? x Were they a key part of former company's operations or sales team?

Creates the highest confidence level with a solid track record of experience, trading practices, and financial strength already known throughout the industry.

Examples include a former officer such as c.f.o., c.o.o., or vice president of operations with several years experience. Generally, these individuals were an integral part of the company through leadership and decision-making responsibilities. As such, they are more likely to lead and manage business relationships successfully.

Examples include a former general manager or vice president of sales, already known to your company. However, given these individuals probably did not have measurable control over how the company's finances were handled, payment procedures and finances of the new firm should be closely monitored.

* Is this a succession of next-generation family member( s )?

It is important to know which family member will be taking control, along with his/her previous role and tenure within the organization. For example, a family member who had an integral role running daily operations over several years versus one who only recently joined the company could have a vastly different effect on the business.

* Do they have little or no industry background and experience ?

The lumber industry is unique unto itself and though a lack of specific experience doesn't mean a company's performance will be adversely affected, lacking an industry track record is an element of uncertainty that won't show up on a balance sheet. When owners without industry experience take over, you must consider their experience in other industries and meet with them personally. Additional questions to ask: Are the new owners actively committed to their customers, suppliers, and the industry? Are they asking the right questions, interested in learning, or acting as if they already have all the answers?

Much to consider

Whenever a company is sold, there are many factors to consider in determining whether to continue or scale back your working relationship. Questions about structure, ownership, finances, and background are essential and must be answered. Blue Book Services uses these very questions and subsequent answers to determine if an existing rating will continue following the sale. You, too, can benefit by asking these questions, or at minimum, obtaining an in-depth Blue Book business repoft as a necessary step in your due diligence.

- Ken Schultz is v.p. oJ rating services at Blue Book Services, a leading credit and marketing inform.ation agency for the lumber industry. He has over 20 years experience with Blue Book and is a certified credit executive. Contact him at (630) 6683500 or kschultz@ bluebookservices.com.

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