Government and private civil litigation have been on the rise in the food industry in recent years. We have seen mandatory recalls, food executives charged with crimes for selling contaminated products, and companies hit with massive class actions asserting fraudulent labeling claims.
For those thinking of acquiring a food company, they should probe well beyond a company's balance sheet to avoid stepping into a potential legal sinkhole. For example, in an effort to rapidly diversify their portfolios with "healthy" or other cutting edge products that may appeal to a new market, some established conglomerates have acquired smaller food companies, which ultimately became significant headaches.
In order to uncover lurking land mines, it is essential to ask hard questions concerning issues such as the target's company's processing of ingredients, its basis for labeling claims, and its insurance coverage. More specifically, I call this looking closely at the company's 3 Ps: Processes, philosophy and protections.
Whether it's the recall of contaminated food or labeling claims concerning words such as "natural," "healthy" or "fat-free," food manufacturers have been subject to hundreds of class actions in recent years. For example, if a company claims that its products are "healthy," it is critically important that the manufacturer substantiate that the ingredients meet the Food and Drug Administration's definition, or the company could be faced with a claim that the product is mislabeled.
Additionally, potential buyers should conduct a thorough investigation of the source of ingredients and quality controls. A company can be exposed to serious liability claims if its ingredients have a high level of toxicity.
Here are three key questions a potential investor should explore when evaluating a food company's processes:
- Is the company up-to-date on the changing landscape of food regulations? Any food manufacturer involved in labeling must be on top of the constantly evolving regulations promulgated by the Food and Drug Administration, the Department of Agriculture, state and local authorities and other regulatory bodies.
- Is the company carefully vetting the claims it is using on its labels and in its advertising? Words such as "natural" and "healthy" should not be used unless the company has studied the regulations and knows how courts are interpreting those words.
- Does the company "push the envelope" when advertising its products? If the company engages in overselling the product with "puffery," it may well be courting trouble. The company may be driving sales with grandiose claims, but the additional profit could be eaten up defending claims by private plaintiffs or the Federal Trade Commission.
In addition to investigating the target's quality control, labels and advertisements, buyers should size-up the management. Some food companies are only one step from a founder's kitchen stove. Sometimes, these founders believe that the brew they dreamed up is the perfect cure for the common cold or obesity. The rise in social media has created a fertile soil for selling dreams of quick health fixes. Hundreds of thousands of potential consumers could be lured into buying useless, relatively inexpensive products, which they are led to believe will replace pricey drugs.
It is time consuming and expensive to develop scientific support for health and medical claims. A company should not go down the road of making grandiose claims unless it is ready to back them up with facts and data. An investor should be very careful when looking at a company making wild unsubstantiated claims about its product--especially health claims--as they may result in legal action from federal agencies--as well as social activists and competitors--which could have serious adverse consequences for the company.
It is also critical to assess past, present or potential future claims against a company. These risks include personal injury claims, consumer fraud class actions, recalls, or government investigations.
Social media is a good place to look for plaintiffs' lawyers who may be trolling for claims against the company. Sites are used to find and sign up new clients for their firms. Even if there are no current claims against the company, there may be claims coming down the road. Investors must carefully analyze the insurance coverage the company has in place. In addition to traditional commercial liability insurance, it's important to double check for coverage for cyber claims, false advertising and product liability, as well as whether suppliers have added the company as an additional insured.
While there is a significant opportunity to profit from the food industry, any buyer must take the time to know the company's processes, philosophy and protections. This due diligence on the 3Ps will lead the investor to a fourth P: Peace of mind.
This article originally appeared in Food Dive.
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