Negotiating provisional purchase deals on acquisitions.
If you're thinking about buying a business but are spooked about the skeletons you might find in the closet after the deal is completed, you may want to borrow a page from Morrie K. Abramson's book. In recent years, Abramson, CEO of Kent Electronics Corp., in Houston, has developed a technique for protecting himself from those sorts of horrors. Instead of making a decision to buy a company in a compressed period of time, he negotiates provisional purchases that don't close for several months. The time lag permits him and his managers to put the potential acquisition through the paces to learn whether the purchase makes sense. Only when they're satisfied that the deal will bear fruit do they go forward.
Abramson began looking for alternatives to the customary approach to due diligence back in 1989, when the then $36-million electronics distributor was gearing up to buy small distributorships in other regions. Under what he calls his "option strategy," he and his managers asked prospective sellers all the questions they wanted and scrutinized the operations before the transactions closed.
So far, Kent (whose revenues for its most recent fiscal year were $95 million) has done two acquisitions that way (and walked away from two others). Here's how it works:
* Negotiating the terms. When Abramson finds a company he likes that's for sale, he and his managers do some initial analysis to determine its operating condition and its potential. If things look promising and the owners are willing to sell, they negotiate an option agreement containing the basic terms and conditions (including the price) of the proposed transaction. "We always spell out some strategic objectives," notes Abramson, "and we ask the seller to make a commitment so we're not wasting our time." The option period for Kent's first acquisition was 14 months; for the second deal, it was 12 months.
* Putting the business under the microscope. During the option period, Kent's managers are more than bystanders. They spend a lot of time on-site operating as quasi consultants in areas including marketing, operations, and computers. Because the terms of the deal have already been worked out, both sides have an interest in improving results. In one instance, Abramson says, Kent lent a prospective seller $1 million for working capital, which was folded into the purchase price. (If the deal hadn't gone through, the loan would have converted into a five-year note at 1% over the prime rate.)
* Making the final decision. Once Abramson and his people have studied and advised a business for several months, he believes they're in a much better position to know what it needs to operate at its peak. He admits there may be higher front-end costs when you take into account the travel expenses and management time associated with this approach versus normal due diligence. "But we'd rather incur the extra expenses up front than have to deal with surprises later," Abramson says. "The beauty of our purchase options is that, as the buyer, we have the right to walk away."