By John R. Brooks and Erwin G. Krasnow, Esq.
This article is the second in a two-part series designed as a primer for buyers who need to make sure that the business of the station they are buying is as represented by the seller. In Part I, “Secrets of Doing Financial Due Diligence,” Radio and Television Business Report, we suggested three ways to verify that unaudited financial statements conform to generally accepted accounting principles (GAAP). In this article, we’ll focus on add-backs, “below-the-line” items, and non-financial issues. {lock}
Add-Backs
At a time when the bid/ask gap between sellers and buyers could be as much as 3.0X Earnings Before Interest, Taxation, Depreciation and Amortization (“EBITDA”) or Broadcast Cash Flow (“BCF”), the add-back becomes the bridge to satisfy both sides. An add-back is a permanent (or at least long-lasting), legitimate and readily identifiable expense cut. Not only do add-backs help bridge the bid/ask gap, they also help the buyer raise more debt by presenting a higher pro forma BCF and EBITDA number to its lender.
In recent years, add-backs have been harder and harder to find as recession-induced austerity, coupled with the pressure of leverage, have squeezed the fat out of many businesses. Still, there may be broadcast properties out there such as legacy family businesses with little debt or orphaned properties in large conglomerates, where the expense structure can be reduced without harming the business. Here are some examples of legitimate add-backs and others that may be questionable.
Legitimate:
- Contractual expenses, such as rent for studio and tower leases.
- Payroll and related benefits. Perhaps there are too many people on the station’s staff, or a station manager is making double the going market rate. Compensation issues are tricky, however, because people are crucial to the operation of a station. It’s incumbent on the buyer to show its lender and investors that a workforce reduction will not be harmful: one way of supporting this assertion is for the buyer to show that it has done this before.
- One-time, non-recurring expenses, such as an unusual hiring or severance expense, an expense for relocation of the studio or a special promotion (like a car or motorcycle giveaway). These are also tricky because sometimes non-recurring expenses end up recurring. So be prepared to defend them.
- Marketing and professional expenses. A case can be made for a reduction in these expenses when (a) the seller has operated at demonstratively excessive levels and (b) the buyer has a track record to point to in similar circumstances.
Questionable:
- Expense reductions that may not be sustainable (for example, deep reductions in personnel).
- Reductions that are relatively small (like office supplies).
- Reductions that can’t be backed up by evidence.
In any event, your investors and lenders will probably allow you only a limited number and amount of add-backs. Many have heard this tune before and have been burned by agreeing to add-backs that haven’t panned out.
Below the Line Items
Below-the-line or non-operating expenses usually refer to the owner’s expense – salary, benefits, perks, management fees. If the owner is out of the picture once the deal closes, it may be perfectly reasonable to assume that these expenses disappear, thereby improving the bottom line. But the buyer will need to determine the value that the owner brought to the operation – does the owner provide valuable services or have close relationships with key advertisers?
Sometimes buyers will agree to subordinate their compensation to a lender, which means in the event of default their compensation will be suspended. But these agreements only work if buyers can demonstrate to the lender that they have other forms of income to support themselves if their compensation is suspended. All too often these agreements are signed without regard to the consequences.
Non-Financial Issues
These issues should be part of every comprehensive due diligence process:
- A thorough analysis of the market and competitive landscape, the population and related demographics of the market, the retail sales and growth rate of the market and the value of the hard assets.
- A detailed engineering report may uncover expenditures that will need to be made if the seller has allowed maintenance and repair to lapse.
- A review of the seller’s fiscal policies and procedures, such as budgeting, approval of sales orders and contracts, billing and collections, spot pricing, traffic, receivables and payables, bank deposits, and security (including everything from ensuring against theft and embezzlement to computer back-up).
One of the key goals of due diligence is to avoid unpleasant surprises at various times during the acquisition process. As we commented in Part I, if you skimp on due diligence at the front end — and risk overpaying — don’t count on making up for any unpleasant surprises by over-performing on the back end.
John Brooks had been a media banker and CFO for over 30 years until losing his teenage daughter Casey to suicide in 2008. Since then he’s turned to mental health advocacy, writing and working with teens in Marin County, California. His memoir, The Girl Behind The Door, was released by Scribner in February, 2016. Reach him at: [email protected] and (415) 272-5123.
Erwin G. Krasnow, a partner with the firm of Garvey Schubert Barer, is a former General Counsel of the National Association of Broadcasters, Washington counsel to the Media Financial Management Association and coauthor of Profitably Buying and Selling Broadcast Stations. Reach him at: [email protected] and (202) 298-2161.
