Mergers and Acquisitions (M&A)

Buying a 21st Century Food Company

A health and nutrition startup should resolve any potential issues with its quality control, labeling and advertising practices before it is acquired.

No doubt about it. The food economy of the 21st century has become diverse and crowded with small, emerging companies seeking to leverage consumer interest in foods that are authentic in their recipes and transparent about their origins. Of course, many of these hard-working, small-scale entrepreneurs look forward to the day when a larger, multinational food company may acquire their unique brands and market niches, and bring their teams into a new corporate fold.

A major food company looking to buy a small startup will inevitably size up the business considering the current, challenging environment for food manufacturers and marketers. Government regulatory activity in food safety and labeling has stepped up in recent years, with mandatory recalls and new labeling requirements. Private class-action litigation has taken aim at food labeling, particularly at “natural,” “real,” “wholesome” and other legally undefined claims. Companies seeking to acquire a small startup firm would do well to look beyond the financial balance sheet to avoid stepping on a legal or regulatory land mine. A small company without adequate resources to guarantee safe products and truthful labeling can quickly become a significant headache for an acquiring company.

Due diligence is the tool in which these kinds of issues can be unearthed in the acquisition process. To uncover potentially significant issues, it is essential for the acquiring company to ask questions about a target company’s processing environment, food safety plans, labeling and claims substantiation, and, especially, whether the target has built a culture of compliance among its managers and employees. Entrepreneurial sellers, for their part, would do well to be aware of the kinds of questions coming their way as part of the acquisition process.

Food Safety

The passage of the Food Safety Modernization Act (FSMA) in 2011 dramatically changed the way FDA approaches food safety, giving the agency unprecedented powers to prevent food safety outbreaks rather than simply responding to them. Under current law, a food can now be deemed legally adulterated unless the food manufacturer or distributor has analyzed potential food safety hazards and established preventive controls to eliminate or minimize them. Food manufacturers must have a written hazard analysis and a written food safety plan that must be available for inspection by FDA. Importers must ensure their suppliers have complied with FSMA. In addition, the law gives the agency authority to order a recall of a food or to shut down a food facility when a product seriously threatens public health.

Potential buyers must understand how a target food company manages food safety issues and how it responds to food safety incidents. Does it have the necessary written plans and procedures? Does it have an effective crisis response and recall plan? Can it effectively locate and withdraw product from the marketplace when a potential harm to consumers is discovered?

Target companies must be aware that FDA mandates that they have a preventive controls qualified individual (PCQI) to manage their food safety programs, and that their managers must obtain this training from FDA-recognized programs, such as those offered by the Food Safety Preventive Controls Alliance (FSPCA), an industry and academic group formed to promote compliance with FSMA.

FDA issued final regulations implementing FSMA in fall 2016, and has gradually begun to educate the industry as to the required controls and supporting programs, e.g., sanitation, supply chain oversight, allergen control and labeling, recall plans, hygiene procedures, food safety training, etc. FSMA regulations, set forth in 21 CFR, part 117, are for the most part final and apply to all but the smallest food manufacturers and importers. These regulations provide the roadmap by which the buyer can determine whether a potential target is “FSMA ready.”

Labeling and Claims Substantiation

The labeling of the target company’s products can reveal a lot about its approach to consumer claims, transparency, culture of compliance and approach to food safety. Is the company up-to-date on the evolving landscape of food regulation? Every food manufacturer involved in labeling must be aware of the constantly changing regulations administered by FDA, USDA, and state and local regulatory bodies. If the target company likes to “push the envelope” when advertising its products, a potential buyer could be asking for trouble. The target may be driving up sales with attractive claims, but defending those claims in private class-action lawsuits could blunt the competitive advantage.

The target can expect to be asked about its procedures for reviewing and clearing 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 what FDA expects in the way of substantiation via “significant scientific agreement” and other regulatory standards. “Natural” and other undefined claims such as “real” or “wholesome” should be avoided unless the company has carefully studied how consumers and the courts are interpreting those words. A company is responsible for substantiating every message a consumer reasonably takes away from its labeling, including the conclusions a consumer may reasonably draw from undefined claims.

The way a company handles allergen statements in labeling—where such disclosures are mandated by federal law—could signal whether the company is taking adequate steps in controlling its manufacturing environment. For example, statements such as “may contain peanuts” or “produced in a facility where peanuts are processed” should not be used unless cross contamination from the disclosed ingredient is impossible to control. The overuse of such statements may signal an allergen control program in need of significant improvement. At a minimum, such statements should lead to probing questions about how the target is managing allergens in its processing facilities.

Other label statements should trigger an inquiry into supply chain practices. For example, “Made for” or “Distributed by” above the brand owner’s name on the principal display panel indicates manufacturing by a third-party contract supplier. Is that supplier following the FSMA requirements? Country of origin statements should lead the buyer to ask about the capabilities and compliance of foreign suppliers. Also, “Made in the USA” is not necessarily just an origin statement, but rather, an advertising claim that must comply with FTC requirements that all or virtually all product inputs are sourced in the United States.

Process labeling claims—“fair trade” coffee, “cage-free” eggs, “rBST-free” milk or “Non-GMO” cereal—require special attention. FTC Policy Statement Regarding Advertising Substantiation requires every marketing claim have a “reasonable basis” in fact. Claims about processing must be supported by quality, sourcing and manufacturing operations that are reasonably designed to support the claim. The processes must be well-established, clearly delineated, thoroughly documented and continuously monitored, with corrective actions being made promptly whenever errors occur. Of course, claims supported by government standards such as “organic” and “USDA process-verified” signal that a company has undergone a rigorous third-party certification review. Does the target have proof that these reviews were completed and that it passed the grade?

In the due diligence process, a target company’s quality control (QC), labeling and advertising practices can reveal a great deal about its capabilities and culture. Many startup companies grow quickly, and their consumer demand and production capacity can outpace regulatory compliance. Probing questions about a target’s food safety and other compliance programs through due diligence can reveal facts and data that will help the buyer decide the true value of the potential acquisition. For the conversations to lead to a successful deal, this phase of the mergers and acquisitions (M&A) process requires transparency and clear communication from both sides of the bargaining table.

EAS Consulting Group’s (easconsultinggroup.com) independent advisor for food law and regulation, Steve Armstrong has more than 20 years of experience advising leading consumer products companies on marketing and regulatory matters. Prior to EAS, Armstrong served as chief food law counsel at Campbell Soup Co., senior marketing counsel at Energizer’s Schick-Wilkinson Sword Division and assistant general counsel for marketing at Unilever United States. He earned his bachelor’s degree from Harvard College and his law degree from Columbia University.

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