Acquired Knowledge Potential Pitfalls In An Acquisition

Dave Sobel, CEO of EvolveTech, a Fairfax, Va.-based provider of managed infrastructure support services to small and midsize businesses in the Washington, D.C., metro area, thought he had the acquisition of a small solution provider all wrapped up. Instead, he encountered a number of issues that could have been avoided with a bit of experience.

"The process was painful, but it exposed flaws in the acquisition process," Sobel said. "But I guess that's a positive. We learned a lot."

Sobel said he was approached in May by a small solution provider looking to sell its customer base and provide employment for its staff. "The deal sounded good," he recalled. "They had a good staff with some skills we didn't have."

New to the acquisition process, Sobel started researching and hired a lawyer to help. One of the results from the preliminary research was to decide to base the deal on realized revenue, which meant that the purchase price would be determined based on the estimated revenue that EvolveTech would make as a result of the acquisition. Payment for the acquisition was structured over three years, with yearly audits of the incremental revenue potentially changing the payment terms.

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"So even if the deal totally went to hell, we wouldn't [have to] pay for something we didn't get," Sobel explained.

Unfortunately, issues started mounting after the deal was signed--issues that should have been addressed as part of a more lengthy due diligence process. "The seller rushed the deal," Sobel said.

JUST THE FACTS
One of those issues was the claim by the seller that EvolveTech would be acquiring its contracts and hiring its employees, but not any of the liabilities. The expectation, Sobel said, was that any liabilities to vendors or others that occurred before the day the deal was sealed would not be assumed by his company.

Potential Pitfall In An Acquistion

• Consider structuring the acquistion based on realized revenue to reduce the risk of anything going wrong later.
• Don't rush the deal--do all the necessary due diligence, not just what you have time for.
• Be clear in terms of any new liabilities--you don't want any surprises after it's too late to back out of the deal.
• Update the new customers' maintenance contracts right away, and avoid multiple types of conracts.
• Inform the employees at both organizations about all the details and implications of the merger/acquistion--surprise means churn for your people.

"But this became a problem with a customer who owed a lot of money and had become a deadbeat," he said. A second problem was that EvolveTech assumed that maintenance contracts related to the acquired customers would be handled in a similar fashion as those that EvolveTech handled in the past. But that wasn't the case, Sobel said. "When we brought several customers into our regimented management style, we found them to be too chaotic in their maintenance," he said. "That caused a lot more customer churn than we expected." EvolveTech was able to solve that issue by consolidating the different contracts into a single contract. "That effort alone helped customers better understand what we were doing," Sobel said. In the future, EvolveTech will address adopting a single contract for the new customers early on in the acquisition strategy. "We will move to our contract at the beginning, and handle the back end later," he said. Sobel also said that EvolveTech should have gotten involved in human resources matters earlier in the acquisition process. "I didn't have any control over the HR part," he said. "The seller essentially told its employees that the company was sold. He put a positive spin on it, but didn't give the employees advance notice and prepare them. That led to a lot of employee churn." The issues have made Sobel a bit gun-shy for future acquisitions. The experience has also caused him to see the value in smaller acquisitions. "Maybe I'll look at one-man shops, and hire the owner and bring on his customers," he said. Sobel is also not discounting the possibility of being acquired. "I won't close the door. But that isn't my end game," he said. Despite the bumps, the acquisition has paid off for EvolveTech. "But was it worth the pain and headache?" Sobel wondered. "Probably not, in the short term." While solution providers normally talk about their success in mergers and acquisitions, Sobel said he felt it was just as important to point out the pitfalls to his peers. "I hope this will help other solution providers be more successful," he said.