Red flags in potential M&As

November 18, 2024
by a searcher from Instituto Tecnológico de Buenos Aires in United States
What are the key red flags (both financial and operational) you look for during due diligence in a potential acquisition?
I’m curious about your insights and experience about the critical aspects to focus on, beyond just the financials. Do you have any best practices for identifying risks early on?
from Allegheny College in Philadelphia, PA, USA
There are various levels of risk, and this list is certainly not inclusive (every deal is different), but some that immediately come to mind are:
1. Employer payroll taxes being properly withheld and paid to appropriate tax authority.
2. Concentration of customers and revenue (70% of revenue from one customer can be a bad thing)
3. Key man risk
4. Pending litigation or uninsured risk exposure
5. Grossly disorganized corporate records and/or misaligned tax records
Another one is suspicious seller behavior or demands. I see someone post about a ridiculous seller demand in the small business subreddit at least once a week. The recent one was refusal to provide financials until a purchase agreement was signed (not an NDA or LOI, a purchase agreement). Now, perhaps the purchase agreement had sufficient language that allowed for the buyer to complete DD and terminate the agreement if needed, but WHY WOULD WE WASTE TIME NEGOTIATING A PSA IN THIS CONTEXT? Often times there are financial issues that need to be addressed in the PSA (indemnification for unpaid tax liability, representations about customer activity, and many others). It is ridiculous to accept demands like this, and it is important for buyers to realize they can, and should, walk away from people like this.
A seller concerned about confidentiality can always redact sensitive information. Refusing to give any information is simply not acceptable and a good reason to stop the conversation.
from University of Massachusetts at Lowell in Chicago, IL, USA