Risk and Compliance are Key Considerations for Food and Beverage Companies in Search of New Avenues of Expansion
April 01, 2016
By Richard Colloca
Richard R. Colloca of EisnerAmper has spent over 20 years advising various clients in the food and beverage industry. Here, he discusses the challenges facing a heavily regulated sector that is searching for new paths to growth. His remarks have been edited for length and style.
MCC: Please tell our readers about your background and about EisnerAmper.
Colloca: EisnerAmper is an accounting and advisory firm with a presence in several marketplaces in the continental United States, including New York, California, Connecticut, Florida, New Jersey and Pennsylvania, as well as in the Cayman Islands. The firm’s Food & Beverage Services group has been representing companies engaged in manufacturing, distribution and retail for more than 35 years. As for my background, I have over 20 years of experience providing audit, accounting, tax and business consulting services to closely held and publicly traded companies, with a particular focus on food and beverage manufacturers, distributors, retailers and food co-operatives.
MCC: How did you come to focus on the food and beverage industry?
Colloca: Early in my career, I was assigned to work on a company that was a very well-known name in the food and beverage sector, a client with U.S. and international operations. And as part of that engagement I learned the business from the ground up. I spent a lot of time not only with people in the accounting and finance departments but also in the operational areas of the company, and I became interested in those aspects of the business. Subsequently, I also represented clients in the supermarket space and had a similar experience, spending a significant amount of time with operational personnel. They’re the best source to learn from because they’re always excited to talk about their business, and I always have tried to absorb as much information as I can throughout my career.
That’s a mind-set you have to develop – to be a student of everything. As much as I consider myself an excellent advisor to our clients, I am always learning the evolving dynamic aspects of this industry from spending time with our clients. They’ve got instantaneous information, and the good companies will use the information that’s applicable to their business in real time. These entrepreneurs consider their business a continuous evolution.
MCC: What significant trends are you seeing in this sector?
Colloca: We’re seeing moderate organic growth – no explosive trends – mainly middle-market companies looking to grow through a variety of means. More companies are expanding their operations, and one of the challenges is always accessing the appropriate amount of capital to support their expansion. It’s still somewhat of a deflationary environment, but many think inflation will start to creep up in 2016, in which case even a small increase could limit expansion and capital expenditures, as well as increase the overall cost of production. On the other hand, states are continuously competing to attract new businesses and new jobs by offering companies a multitude of tax incentives in order to remain in or relocate to that state.
We’re also seeing a heightened awareness of the barriers to entry in various markets and how companies are looking to separate themselves from their competitors by offering their customer base not just a product line but also integrated services and solutions; and as a complement to that, some companies provide managed services to help their customers improve operations, become more efficient and cut expenses.
Some of the managed services I’m seeing involve supplier integration, similar to the way the logistics brokerage industry operates, where a large company, instead of dealing with 100 different freight vendors, might use a broker to maintain all those relationships. On the managed services side, in some instances we’re seeing companies offer services that can include managing data analytics, workforce strategies, software development and supply-side integration.
These expanded business lines offer a complement to their existing products or services, which enables a company to differentiate itself from its competitors and emerge as a market leader.
MCC: Can you talk a little more about the barriers to entry of greatest concern to your clients?
Colloca: One common barrier is that we are in a compliance-oriented environment. Companies want to make sure that they are allying themselves with vendors that have good systems, controls and protocols in place. Getting through an RFP process takes much longer because the issuers are requiring more and more information to make sure that their vendors’ systems are compliant. They want to make sure, for example, that they’ve got those procedures in place for complying with the Food Safety Modernization Act (FSMA), which has given the FDA the authority to regulate the manner in which foods are cultivated, grown and processed. As a matter of fact, there have also been enhancements to the Food Labeling Requirements as well as additional nutritional disclosure requirements, which affect chain restaurants and prepared foods. In the food industry, margins are historically tight, and now you’re adding additional costs. Certain parts of the FSMA will be kicking in over the next 12 to 18 months, and there’s some concern as to how costly it will become. Companies are doing projections, but until they actually implement it in full, there’s no way of really knowing the total financial impact to a business. Another barrier to entry for a company to be aware of is the concern of cybersecurity controls. It’s important for a company to establish and demonstrate that they have cybersecurity controls and protocols in place.
MCC: What do you expect to see in M&A in the food and beverage sector over the next year to year and a half? What, if any, obstacles should our readers be aware of?
Colloca: The industry is experiencing an upward trend in most sectors. Middle-market companies know their organic growth is limited and that they will hit a ceiling at some point, and that M&A is the only way to take their business to the next level, especially in fragmented industries. So business combinations have been trending upward. One interesting thing we see in the marketplace is the instance where large companies that have foreign-owned entities are employing tax strategies whereby the foreign-owned entities have been acquiring U.S.-based companies with their accumulated earnings, some of which were earned in the foreign jurisdiction. In those instances, it’s a mechanism of reducing their need to bring those foreign earnings back to the United States, which then enables them to deploy that capital into M&A. The end result of it is you’ve seen higher multiples in the marketplace. Tax inversion strategies in general have increased over the last several years. The relatively recent merger between Burger King and Canadian coffee chain Tim Hortons, with the two joining forces to become the world’s third-largest fast food chain (behind McDonald’s and KFC), involved a much-discussed tax inversion deal.
In terms of obstacles, competition continues to be intense. An example is how food products, which were primarily sold only in grocery stores at one time many years ago, are now also being sold in a variety of big box,specialty and drug chain stores.
MCC: There have been some big headline-grabbing proposed mergers of late, like between the two big beer giants. Have they spilled over – no pun intended – to the sector generally?
Colloca: These types of mega-deals have affected our clients. There’s a ripple effect because when these types of mergers occur, it can lead to vendor consolidation across many sectors. On one hand, this can be a threat to some companies; conversely, it can also be a new opportunity.
MCC: For companies with an urge to merge, do you have any advice regarding due diligence?
Colloca: Whether the due diligence is buy side or sell side, it needs to be extremely comprehensive. Many companies don’t initially realize the massive undertaking that’s ahead of them and the time commitment it entails. Conducting due diligence while dealing with the everyday challenges of managing a business is a real balancing act. And that’s where hiring strategic advisors as part of the overall M&A process can be prudent. If we’re advising a seller, we start, very early in the process, accumulating the information that potential buyers will be interested in; information that companies may not always have readily available through their systems.
Gathering and providing that information is a very labor- and time-intensive process, so it’s important to develop a team of advisors and dedicated, internal personnel who can assist in moving the process forward in an efficient manner.
MCC: Does due diligence differ for each subsector, e.g., organics, produce, meats, dairy, beverages, spirits, vitamins, supplements, etc.?
Colloca: Every segment has its own key drivers for such transactions. One commonality in the food and beverage space, I would say, is insurance coverage. Potential buyers may require the seller to purchase additional coverage for product liability or recall-related claims depending on the circumstances.
MCC: Have any deals fallen through because of concerns about the adequacy of coverage for food safety liability risks?
Colloca: No, but I’m seeing more protracted negotiations over the purchase price. And it’s understandable that a potential buyer is going to be very cautious in that area as part of their overall risk management.
MCC: Supply chains and the manufacturing and distribution process can pose high risks for a food and beverage company. What are some of the keys to maintaining and demonstrating compliance?
Colloca: Compliance and risk management are a crucial part of the business. ISO certification, which requires implementation of quality management systems covering facilities, personnel training, services and equipment, is more important than ever. For example, ISO 22000 addresses the identification and control of food safety hazards and includes guidelines for food safety management and the traceability of products in the food chain, as well as specific prerequisite programs for food manufacturing, catering and food packaging. For the past several years, there’s also been a focus among risk managers on disaster recovery plans, data security and cybersecurity risks as we discussed earlier.
Risk assessment has become a focal point of compliance in many industries. In the food and beverage industry, the FMSA has taken center stage in that discussion, and the key issue has been how best to ensure that one’s vendors are compliant with the act. This is where having a strong advisory team is very important. Insurance has also been a key issue, as many policies may not cover product recall and related advertising and public relations costs. Whether as part of M&A due diligence or contracting with suppliers, we advise our clients to make sure coverage is in place for these risks and continually monitor it accordingly.
A PR damage control plan is especially important when it comes to cases of food-borne illness. When people think there’s even the slightest chance a food manufacturer or retailer has food safety issues, the news will spread like wildfire, and the damage can be devastating. It’s important to have a detailed plan in place for a range of possible scenarios, so you can act immediately to mitigate the damage. We’ve worked closely with companies, advising them on how to develop such plans, which include selecting their team of professional and legal advisors before any incident that may occur.
MCC: For companies involved in import/export, what are some risks they should be aware of? Are there any new regulations they should be aware of?
Colloca: Again, I would point to the FSMA, which includes a foreign supplier verification program that will focus on ensuring that food coming into the United States has been produced in a manner that meets the U.S. safety standards. While the act was originally passed in 2011, parts of it become mandated at different times. For the part applicable to importers, the effective implementation date is May 2017.
MCC: What are some of the most frequently asked questions or issues that arise during an audit of a food or beverage company?
Colloca: On the financial statement side, questions relating to product liability arise. Auditors want to make sure that companies have systems in place for identifying any potential liability claims that may be out there and their ability to trace and track production lot numbers for a potential product recall. They also look at systems for monitoring the shelf life of products and other potential obsolescence issues. They’re interested in what kind of internal controls are in place for rebate and incentive programs, whether directed to distributors or retailers.
When rebate programs rapidly accelerated in the ’90s, the challenge for us was how to account for them on a timely basis, since many of these deals lacked concrete documentation. In today’s environment, most of these deals are well-documented, and some are formula driven. Companies have also adopted protocols which provide that any rebate program negotiated by operational personnel includes a direct reporting mechanism linked to the accounting and finance departments.
Lastly, the implementation of the Sarbanes-Oxley Act for public companies has created a positive effect for private companies since the act requires maintaining adequate internal controls. This has led to enhanced documentation by all parties.
MCC: Are there any tax benefits available to the food and beverage industry that our readers may not realize are available, or are not making the most of?
Colloca: There are a lot of research and development (R&D) credits that are available. Companies are always spending money in R&D as a means of growing their business. It's certainly worth their while to have R&D studies performed to determine if any of their expenditures qualify for tax credits. A key control piece for R&D, therefore, is making sure that protocols are in place to ensure that R&D time and expenses are properly captured, that the company has a good trail of information for its R&D spend, especially if it’s related to internal personnel. Claiming that an employee spends, say, 10 percent of his or her time on R&D without adequate documentation is simply not enough to claim the credit. The employee needs to document what R&D projects he or she worked on, how many hours he or she spent on those projects, etc.
MCC: Any other closing thoughts?
Colloca: The Food and Beverage market is a dynamic, highly competitive and continuously evolving industry. The issues have become much more complex; so we would recommend discussing these issues with your advisors routinely in order to remain prepared and proactive.