• To Management - One of the claims made by Kelco is that Monsanto did not allow sufficient access to the biogum division’s operating executives in the due diligence period. As a general matter, buyers should always seek access to key operating personnel in an atmosphere that is conducive to open and honest discussion. While this type of access is normally not allowed in the early stages of due diligence, it usually is appropriate at later stages and certainly before the buyer commits to the deal. In the early stages of due diligence, it is common for the seller to make management presentations for potential buyers. These are often scripted affairs in structured settings where real access is limited and in many cases discussions with management are prohibited or carefully monitored. At a later time, before closing or committing to a deal, the buyer should insist on having more free-flowing access to key personnel.
  
  
• To Key Customers and/or Suppliers – While not an issue in the Kelco-Monsanto dispute, lack of access to key customers or suppliers in some deals could also raise a red flag to a buyer. When a business is dependant on a very large customer, or on a key supplier, a buyer may want to meet with the customer or supplier prior to closing to get some comfort that the relationship will continue after closing. For sellers, this can be a very sensitive issue, and so access is normally granted, if at all, only at very late stages, just prior to closing.

Rosy Forecasts/Hiding Negative Forecasts - The Kelco-Monsanto dispute also involves an element that is quite common in many divestitures – rosy forecasts, or its corollary, the hiding of negative forecasts. Red flags should go up to any buyer whenever a seller paints a picture of the future that is significantly better than the past. We have all seen such “hockey stick” projections. While such projections may have a sound basis, they normally do not and it is prudent for a buyer to be skeptical at first and demand that the seller explain its projections thoroughly.

Cooking The Books – The Kelco-Monsanto dispute also involves something that is much less common than the rosy forecast - i.e. manipulation of the historical earnings of a business. Kelco maintains that Monsanto’s customers were induced to make early purchases through price discounts, which moved income from 2000 to 1999 and had a negative affect on pricing in 2000.


How To Deal With Red Flags

There are a variety of ways (some of which overlap) for a buyer to deal these warning signs.

1. Don’t Close - Perhaps this is all too obvious, but in many deals there is a pressure to close regardless of what problems come up. It may make sense for a buyer to step back, take stock of where it is, and say, for example “We can’t close unless we have a full and frank discussion with operating management”.
   
   
2. Reduce the price - Another obvious solution in many cases. It should be noted that in the Kelco-Monsanto deal, the original price was $685 million and was ultimately reduced to $592 million, no doubt taking into account many of the red flags raised in due diligence. Apparently however, the price was not reduced enough.
   
   
3. Use Contingent Payments - Making part of the purchase price contingent on future financial performance is a common way to solve the “rosy forecast” scenario or where there otherwise is an uncertainty about the prospects of a business.
   
   
4. Put It In The Contract – If, for example, a rosy forecast is being used by the seller to justify a higher price for the business and a contingent price structure cannot be agreed to, it is reasonable to ask the seller to represent that the forecasts have been made in good faith and are management’s best estimate of future performance. If the seller chokes on this, the forecasts should be discounted significantly or perhaps entirely.
   
   
5. Buy Someone a Drink - This solution is not as facetious as it sounds. As mentioned before, the divestiture process is often a scripted affair, with formal presentations and rigid rules. There have been many deals where an eleventh hour “confession” or other type of candid conversation with a key manager takes place before closing in an informal setting such as at a bar or at dinner. It is in this type of atmosphere where a buyer can gain valuable information about a business that does not surface in the formal divestiture process. If a seller will allow such a meeting, it is highly recommended. If not, raise the red flag.