Enhance Your Dairy’s Value with Sell-side Due Diligence

Michelle VanDellen, CPA, Senior Manager & Ryan Kuenzi, CPA, Partner Agribusiness Tax Practice, Moss Adams

Michelle VanDellen

Conducting sell-side due diligence helps increase the probability the sale of a business will be successful. Performed correctly, the process uncovers opportunities for sellers to enhance their company’s value prior to a sale while helping facilitate a faster close time. In addition, companies contemplating a sale can often benefit from leveraging sell-side due diligence to advance their strategic goals.

Here are answers to some of the most important questions facing dairy farmers prior to and during the process.

What Are the Benefits?

Sell-side due diligence is a proactive process that involves identifying and assessing issues and trends that either positively or negatively impact business value from a buyer’s perspective. Business owners gain early, vital insights this way, which can help establish a strategic framework for selling the company later on.

 

Presenting Favorably

Armed with the due diligence findings, sellers can address material weaknesses prior to a sale and prepare for questions they’re likely to face from buyers. The process also provides sellers a reality check against their own expectations of business worth and deal value. With greater control over the sale narrative, sellers can project greater confidence in their position, helping to bolster a buyer’s perception of the company.

 

After conducting sell-side due diligence, companies are also often better positioned to avoid major surprises or gaps in expectations that could delay or kill a deal. There are also generally fewer unforeseen costs and added professional or consulting fees, which can result from a lesser degree of preparation.

Enhancing Deal Value

Insights gained from the due diligence process often point to transaction structures that could help increase deal value as well as after-tax proceeds. By identifying weaknesses that could reduce deal value, sellers, together with an advisor, can usually anticipate buyer negotiation tactics as well.

By proactively managing the way issues, processes, accounting policies, and other aspects of the business are presented during negotiations, sellers can better anticipate buyers’ questions and keep the discussion focused on the strategic basis for the transaction.

Managing Workflow

Sellers can leverage due diligence insights to proactively manage the stress of a future transaction on a business by gathering company information that will be requested by a buyer in advance.

The demands placed on a company’s internal resources to support a transaction can be intense, and senior management is usually hit hardest as they struggle to balance go-to-market preparations with maintaining successful operations. Sell-side due diligence helps avoid excessive demands on management’s time and eases the potential disruption of buyer requests.

What are the Key Concerns for Dairies Preparing for a Sale?

Sell-side due diligence helps sellers identify and address weaknesses such as these that are specific to their company. These are some additional areas where dairy and other agribusiness companies can fall short:

Cost Accounting Systems—Prospective sellers should have command of their production key performance indicators across all aspects of their operation, such as herd replacement costs, feed consumption per cow, production per cow, milk quality, and break-even milk price.  Accrual basis accounting is a must.

Purchasing Systems—Capturing feed, manure management, and other cost trends and their impact on gross margin isn’t often part of a company’s purchasing systems; however, it’s information that buyers will want to know.  A buyer will want to know your dairy’s efficiency in producing each cwt of milk.

Up-to-Date Inventory Information—Dairies often lack the inventory systems and the data required by buyers to assess the historical yield rates, product quality, and potential reserves needed on balance sheet accounts.

Animal Health and Production—It is important to maintain and update vaccination, health and breeding records as well as historical nutritional data. Do you have written employment policies in place regarding animal handling and welfare?

Human Resources—Are your Employee onboarding processes and handbooks up-to-date? Are you in compliance with local, state, and federal workplace regulations?   Do you have procedures to manage Workers Compensation and Unemployment claims?

Environmental—Are you in compliance with local, state, and federal environmental regulations? Do you have appropriate manure management and fertilizer/pesticide application records? What is the status of your existing water rights or water right applications?

Technological—Have you evaluated the implementation of labor- and time-saving technologies, such as robotics? Is there current cost-benefit data to support your decision regarding implementation?

Transaction Tax Reporting—Appropriate time and attention should be given to quantifying the following:

  • potential amount and character of gains reported in the sale of your dairy operation up front.
  • the tax impact of ceasing operations. While of importance to all taxpayers, this is crucial for operations utilizing the cash method of accounting for income tax purposes.

Knowing your tax efficiency (or lack thereof) is critical in the sell-side diligence process.

In the event a company decides not to sell, it’s stakeholders have still gained invaluable insight about the organization’s profitability, performance, and other drivers of value they can then focus on improving.

When Should Companies Think About Preparing for a Sale?

Given the ups and downs of the dairy cycle, businesses should ideally start preparing for a sale three to five years in advance. This timeframe provides the sellers ample opportunity to begin positioning the company for sale, preparing multiple years of performance data, and putting systems and information in place that’ll be seen as desirable by potential buyers. It also gives sellers time to adjust their income tax deferral and payment strategies.

Final preparations, including conducting sell-side due diligence, should begin six to twelve months prior to the anticipated go-to market date. This allows enough time for the seller to organize financial information and prepare management for a potential buyer’s due diligence process.

What Can Companies Do If Deficiencies Are Found? 

Deficiencies found during sell-side due diligence can and should be mitigated. It’s important to note, though, that when it comes to changing policies, reporting, or processes, the closer companies are to a planned transaction, the more difficult it becomes for buyers to assess what’s normal or the impact of those changes.

If possible, sellers should avoid making changes to significant accounting policies and financial reporting systems within a year or two of a sale. Having consistent information makes it easier for buyers to assess the merits of a transaction.

To the extent deficiencies are found, pro forma adjustments can be made during sell-side due diligence to account for these items, rather than changing the underlying data in the system.

Can Sell-Side Due Diligence Help Address Industry Trends?

The process can help an organization prepare for and proactively manage outside factors, such as:

Commodity and Labor Prices

Volatility in commodity prices is the “new normal”. Being able to explain the impact of fluctuating costs for feedstuffs, labor, and overhead on gross margin is critical during the sales process.

Milk Processor Concentrations

Dairy operations will continue to have a high level of customer concentration. Management will need to be able to demonstrate to a potential buyer the strength of the company’s relationship with key processors.

Debt Leverage

Increasingly, debt leverage is being used to fund transactions. Because of this, normalized earnings before interest, taxes, depreciation, and amortization (EBITDA) has become more crucial to supporting buyer valuations and acquisition models. Surprise adjustments become even more problematic in these scenarios.

Paying More for a Good Reputation

While most dairy operations don’t maintain their own unique brands, the strength of the dairy’s operations, cost management, labor management and herd management impact the value of the operation. The extent to which a seller is prepared to tangibly demonstrate these attributes can enhance buyer perceptions exponentially.

Vertical Integration

Large corporate buyers continue to be interested in acquiring all aspects of their value chain (input production, processing, and distribution). The more control that their operations have over the production of their input streams, the more profitable and viable they will be when negotiating with large processors, distributors, and retailors.

We’re Here to Help

Large buyers recognize that it can be an inefficient use of their capital to start a dairy operation from scratch. If you’d like to learn more about how sell-side due diligence could benefit you and your company, contact your Moss Adams professional.

Moss Adams is a full-service accounting and consulting firm with locations across the western U.S.  More information available at https://mossadams.com/home.