The art of the deal

Claude Solnik, The Daily Record Newswire

When Jenkens & Gilchrist, a Dallas-based law firm, merged with Manhattan-based Parker Chapin Flattau & Klimpl in 2001, it seemed like a match made in heaven. The Texas firm would get a large New York presence and Parker Chapin would become part of a national firm.

Things didn't work out quite as planned.

After the Internal Revenue Service announced it was investigating the national firm's tax shelter advice, the deal suddenly began to look like a disaster for Parker Chapin. The IRS sued Jenkens & Gilchrist in 2003, and partners defected en masse as the Department of Justice brought charges, before the merged firm agreed to pay $76 million to the IRS and disband as of March 31, 2007. By then, the attorneys in the New York office had bolted and the merger had turned into a cautionary tale.

"There's no way Parker Chapin could have known about this tax fraud scheme," said Thomas Huszar, chairman of Garden City-based Moritt Hock & Hamroff's corporate, securities and financial services practice group, who was with Parker Chapin at the time. "On the heels of announcing its merger, all of a sudden the Department of Justice comes in and slaps the firm with a real issue."

Although the best due diligence can miss fraud, stories of mergers and acquisitions gone bad point to the risks as well as the do's and don'ts of a deal where the devil can be in the details or, as in Jenkens & Gilchrist's case, in the lucrative Chicago office, where the fraud occurred.

"When you're rushing to get your due diligence done by end of year, that's when mistakes get made," Huszar said of one risk. "You have to take your time."

Attorneys and accountants who advise on mergers and acquisitions point to the need for extensive due diligence and the importance of evaluating culture. Firms need to look not only at financial statements, but operations and risk management including sudden, rapidly growing revenue sources.

"The biggest reason I see mergers not happening is there's more exposure than what [the merging parties] intended lawsuits, debt and other liabilities," Huszar said. "You're merging with a company and you see the way they run their company, that they don't use best practices."

Deals are scuttled after acquirers discover a history of discrimination, outstanding claims, problems with unions, banks' concerns and litigation. But the decision not to disclose negative information can be an even bigger problem than the initial issue.

"Don't hide things," said David Hillier, a partner at Bertram Capital, a middle-market private equity firm in San Mateo, Calif. "We just got very close to a deal. Then we found out an executive was a convicted felon for check-kiting," a form of check fraud in which checks are drawn against an account containing insufficient funds.

"If there are problems for the business, get them on the table," Hillier advised. "Deal with them on the front end. You can save yourself, and your banker, a lot of challenges."

As deals are based on trust, when one side finds out information wasn't disclosed, that lack of disclosure puts the executives' integrity in question.

"It's critical to establish that trust early on in the sale process. If somebody thinks you're hiding something, particularly if it comes up at the last minute, you're done," said Scott Sanders, vice president in charge of corporate development at Melville-based Henry Schein.

Culture is key to any deal. Companies need to be compatible, a component many people focused on finance miss, according to Huszar.

"Companies have workplace, management culture," he said. "Are you a hard-charging, aggressive company or a family-owned business?"

Henry Schein, a global provider of healthcare products, makes as many deals as any Long Island-based company. But the biggest reason for taking a pass isn't that the numbers don't work out. Henry Schein goes way beyond the books when deciding which mergers to approve.

"We'll pass on deals if the cultural fit isn't there," Sanders said. "We spend a lot of time getting to know the teams of all the potential candidates and gravitate quickly to the ones that share our culture, values and ethics."

Firms also need to provide enough information for acquirers to validate claims. The financials need to be clear and, ideally, reviewed by a reputable accounting firm.

Executives also need to be informed: They have to know their costs, revenues and margins rather than simply using a business as what Huszar called a "family piggy bank."

"For any acquisition, if you're going to be selling, you have to have professional, transparent management in place," Huszar said. "You have to be able to clearly show costs, profits and revenues."

Marc Essenfeld, CEO of Carlstadt, N.J.-based Tribeca Oven, acquired by CH Guenther, said sudden shifts in a business can spook a partner. Companies like to see a steady business, rather than one with sudden, inexplicable spikes.

"When you tend to have huge fluctuations in revenue and P&L [profit and loss] that can't be explained, it looks odd," he said. "You have a confidence issue."

Essenfeld said firms need to present an honest picture of their fluctuating business.

"Talk about some of the opportunities, but maybe some of the weaknesses as well, and why this partnership can grow at a faster rate," Essenfeld said.

Executives also need to be prepared, knowing not only their firm, but the potential merger partner or acquirer. Each side wants to know the other is serious about considering a match.

"I've seen it many times," Sanders said. "They come into a room for a management presentation. Some have done no research, no homework and don't know anything about the buyer. They can't articulate why the business would be good in tandem."

Caution should be exercised early in the process not as an afterthought. If two companies aren't a good fit, it's better to figure that out sooner than later.

"If you're going through a process, trying to find the right buyer or the best price, sellers could do themselves a favor by doing their homework and being thoughtful about opportunities," Sanders said.

Published: Mon, Jan 05, 2015

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