Food technology – from 3D printing to emerging categories of food like cell-based proteins and vegan fast food – is rapidly making major advances. For those who are interested in getting in on the ground floor in new advances in plant-based foods, for example, it would be wise to probe well beyond a company's balance sheet to avoid stepping into a potential legal sinkhole. In recent years, we have watched as some established conglomerates, in an effort to rapidly diversify their portfolios with "healthy" or other cutting-edge products that may appeal to a new market, 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. Investors must look closely at the company’s three P’s: Processes, Philosophy, and Protections.
Processes
Whether it is the recall of contaminated food or labeling claims concerning words such as "natural," 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, as a company can be exposed to serious liability claims if its ingredients have a high level of toxicity. Toxins can be introduced into the food from ingredients which are purchased from suppliers, or as the result of the company’s manufacturing process itself. No matter the source, the discovery of toxins can turn a potentially profitable product into a financial disaster in only a matter of days.
Among the questions a potential investor should explore when evaluating a food company’s processes include:
- 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. Products sitting on retail store shelves, with labels containing those words, will undoubtedly grab the attention of plaintiffs’ lawyers, whether or not they attract more consumers.
- 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.
Philosophy
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, social activists, and competitors -- which could have serious adverse consequences for the company.
Protections
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. Legal technology is very advanced – with one click the entire legal history of a company, a product or an ingredient.
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 is important to double check for coverage for false advertising and product liability, as well as whether suppliers have added the company as an additional insured. The growth of hacking and ransomware have added another essential form of coverage – cyber insurance.
While there is a significant opportunity to profit from the food industry, any buyer must take the time to research and develop a nuanced understanding of 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 on June 9, 2021 in Nasdaq.
