Acquisition mission: (a brief journey from theory to reality).

Has a client ever invited you to meet and discuss an acquisition? Usually, the meeting would include you, your client and the client's attorney discussing the acquisition target. You listen while the attorney describes the steps in the process, and check in with tax suggestions of your own. Financing issues are reviewed and everyone shakes hands. Driving back to the office, you mused about sending a bill for $1,000 at the end of the month for "discussions relating to a proposed acquisition.

Hold the champagne! You just missed a great opportunity.

Your education and background make you invaluable during an acquisition. CPAs are trained and experienced in investigation, evaluation and organization of data, and these skills make you a key player in the acquisition process. If you lack any information in industry knowledge, tax sophistication or valuation skills, you know how to find it.

[ILLUSTRATION OMITTED]

Here is a step-by-step acquisition format. It covers acquisitions only of privately held companies by other privately held companies, but many of the strategies and tactics are similar for public company acquisitions, though the statutes, rules and regulations governing such transactions are more extensive than can be covered here.

PREPARING THE CLIENT TO BECOME AN ACQUIRER is step one, but it's usually missed, except by experienced companies. Many acquisitions fail because the acquirer's management is not ready for its expanded role. This is especially true when the acquired entity is expected to operate as a standalone unit rather than a tuck-in to current operations.

Early in the discussion, make sure you understand your client's goals in making an acquisition. It's also a good investment in your time to help your client form an acquisition team. Generally, this team will consist of your client's CFO, lawyers, bankers and investment bankers. Internal control issues and any lack of management depth must be addressed ahead of the acquisition.

SELECTING A TARGET is next. Using the skills of an investment banker, create a list of targets. Through available (and usually local) business sources, prepare a wish list. Is the client seeking a strategic acquisition, one that complements current operations or eliminates a competitor? Or is it a financial acquisition, one required to stand alone and produce a return on investment? This distinction is vital and affects selection, valuation and control issues. You can research information through websites, credit reports, SEC filings and other sources. If your firm is larger, poll your partners and senior staff to find your internal resources.

APPROACHING THE TARGET is a task many accounting professionals would rather avoid. However, you'll likely find that most targets are flattered by your interest. Your firm may have resources that are useful as you make this initial contact. Or consider potentially helpful community or industry contacts. Even a cold call works on occasion.

[ILLUSTRATION OMITTED]

Once you contact the target, be prepared to assist attorneys in preparing a confidentiality agreement. This document is key in establishing a working relationship with the target's owners and management. As soon as you establish confidentiality, you should request financial information. You won't get much at this stage, but you'll require enough data to formulate a valuation and acquisition-financing plan. When you have a feel for the target's financial data, determine an acquisition format. Should the client be buying stock or acquiring assets? What about debt? Does real estate belong in or out of the deal? Are there special issues, such as an ESOP? Develop a checklist and keep it current.

VALUATIONS ARE THE MOST COMPLICATED of the challenges encountered in an acquisition. There are buckets full of "rules of thumb" and other mathematical ratios, such as multiples of earnings. They are useful as negotiating tools but a fantasy for meaningful evaluation. Learn them, but don't rely on them.

In my opinion, the one dependable evaluation technique is discounted estimated future cash flow. Study the various methods of estimating anticipated cash flow and financial modeling. One potential error is to formulate cash flows without provisions for future capital expenditures, or without considering tax consequences. To apply discounts, you need to know what discounts make sense. Some of the types you might consider are: value of money; industry risk; key man management risks; and product risk, where a proprietary product is significant.

Keep in mind you're working in a preliminary environment using available financial information. Carefully note your assumptions, which will form the basis of the work you do later in the financial due diligence review. One useful tool is to formulate an earn-out period after the acquisition is completed. This is the period in which the acquired entity will be obligated to justify its presumed value.

Having reached a rational assumption about the target's business value, consider other items of value not covered in the cash flow model. These include items such as real estate owned; real and personal property leases; retention of key employees; patent rights and other types of proprietary products; warranty responsibilities; key vendors; key customers; and the particular business environment.

After reaching a preliminary estimate of value and acquisition method, begin working with attorneys on a term sheet. With an eye to negotiations, the acquisition team should decide whether to issue a letter of intent or actual acquisition agreement. I believe a letter of intent is all but useless. Some sellers--usually first-timers--need to proceed document-by-document so they can argue each point. Most acquisitions involve targets owned by founders, who are usually first-time sellers. Sometimes it almost seems like you are trying to buy their children.

IN FINANCING THE ACQUISITION, you demonstrate your value to the client. Depending on the purchase price and seller financing, the acquisition's success may depend on your skill in financing. Working with your client, their CFO and bankers, dig through all available options, including long-term financing of the acquirer's long-term assets. Perhaps you can delay the payment of a large portion of the purchase price by the terms of the transaction. In some industries, it's common to use a future time period to determine sales price. For example, in the uniform rental business, you frequently evaluate targets based on rentals earned over the subsequent 52 weeks.

Interest rates are negotiable. Don't hesitate to shop for better terms, rates and conditions. There are many types of lenders, each with its own methods and cost structures. Take time to visit credit grantors and understand each one's approach to various transactions.

TAX ISSUES are a place where CPAs feel at home. Keep in mind all types of taxes that might be involved in the transaction, not just income taxes. You should be familiar with transactions that might be either taxable or non-taxable to the seller. One difficult issue arising between buyer and seller is the allocation of the purchase price. This allocation, required for both buyer's and seller's tax returns (see IRC Sec. 1060), controls such items as basis of assets transferred, sales and use taxes, and depreciation and amortization.

CPAs wanting to be professional about the tax implications of acquisitions should be familiar with IRC Sec. 197, Amortization of Goodwill and Certain Other Intangibles. Many other tax situations will arise in connection with the acquisition and must be handled competently. If you don't specialize in this area, add a tax specialist to the acquisition team. With experience, you may be asked to solve the seller's tax problems--real or imagined--to make a deal work. You also need to be aware of tax and regulatory issues in the employment area, such as those covered by ERISA and the WARN Act, including the filing requirements.

THERE ARE TWO TYPES OF DUE DILIGENCE REVIEWS. One review focuses on internal control measures, as well as other office procedural and administrative structures. Your client wants to know that the target has controls in place to assure that internally prepared financial reports are free of material misstatement. The other review concerns understanding and documenting the business strategies and tactics that make each acquisition unique. Unless you have specific industry expertise, you may need help. Both reviews are vital to the acquisition and demonstrate the importance of a CPA's training and experience.

A word of caution: Document how you check the assumptions you made when you reached tentative conclusions about future anticipated cash flows and the discounts that apply. The validation--or lack of validation--of these assumptions will either justify the purchase price or change it, perhaps radically.

And, if the sales price changes, it most certainly will affect the deal structure, as well as its terms and financing. Most clients don't understand due diligence reviews, so make them the subject of a separate engagement letter with separate pricing. Do this well in advance of their occurrence.

THE NEGOTIATIONS LEADING TO AN AGREEMENT are the most enjoyable part of the acquisition. But, if it's not of interest, don't get too involved. Other team members--your client, an investment banker or attorney--will be happy to take on the laboring oar. Even if you want to be involved, stick to the business points in which your training and experience make you sensitive to practical situations.

A great deal of acquisition negotiations are about the terms and conditions of the seller's representations and warranties. As much as it might seem otherwise, these representations and warranties are strongly influenced by practical business points. The more you participate in acquisitions, the greater your ability to contribute to these negotiations. One of the words most highly prized in these discussions is "materiality," and who knows more about measuring materiality than you?

IN THE DOCUMENT REVIEW, be certain that the concepts you advocate regarding deal structure and tax matters are worded to your satisfaction. Do the document review as quickly as possible and be cautious of the wording of representations made on accounting matters. Many documents contain provisions requiring the books and records to be kept in accordance with the target's past practices and GAAP. You are apt to be more familiar than other team members with GAAP. If these provisions don't make sense to you, suggest that they be deleted.

[ILLUSTRATION OMITTED]

GETTING PAID for your professional services is important. Of course, you should discuss this subject early in the process. I've found it's a good idea to repeat--and re-estimate--your fees at several points along the way. It's impossible to accurately estimate the time you'll spend in due diligence or the negotiation process, for example. Deals often fail to come to fruition for a variety of reasons, including disagreements about valuation and terms of payment. It's a good idea to agree with your client in advance about how you are to be paid if the deal is not consummated.

A CAUTIONARY NOTE, be aware of certain areas of sensitivity. First, if this particular client is an attest client, you have to take steps to protect your independence and so you may be precluded from certain aspects of acquisitions. Next, if you're planning to value bill or request a fee contingent on the successful completion of an acquisition, be aware of the definition of a contingent fee. California Board of Accountancy Rule 62 provides, in part: "... a contingent fee is a fee established for the performance of any service pursuant to an arrangement in which no fee will be charged unless a specific finding or result is obtained, or in which the amount of the fee is otherwise dependent upon the finding or result of such service."

Other guidelines and prohibitions in CBA and AICPA rules and regulations may apply, such as confidentiality. It's a good idea to review these rules and regulations periodically. Good luck and good hunting!

BY LOU SAVETT, CPA 

Lou Savett, CPA, is chairman of Santa Monica-based Gumbiner, Savett, Finkel, Fingleson & Rose, Inc. and president of the California CPA Education Foundation's board of trustees. He can be reached at [e-mail].