Keen due diligence can help determine the final price in business acquisition.
A due diligence team is comprised of management representatives and transaction support advisors that can include a CPA firm, financial consultants, forensic experts, appraisers, insurance, risk and technology specialists, intellectual property experts, bankers and investment bankers and legal counsel.
Before the deal is penned, the team would assist in constructing the Letter of Intent (LOI) based on a preliminary review of the data provided by the seller. The LOI addresses key terms for the transaction such as how the final price is determined, what assets are acquired, form of payment (cash, notes, stock, and/or earn out), closing schedule, possibly the amount of the escrow, scope of due diligence and transaction drivers.
Following the LOI, the buyer proceeds with due diligence. As a first step the team familiarizes themselves with the company’s history, ownership structure, board minutes, major products and customers, markets, financial statements, profit margins, cash flow, loan agreements, tax records and compliance, contracts, leases, regulatory records and filings, labor contracts, employee listings with salaries, pension records, bonus plans, personnel policies, insurance policies, site evaluations, environmental issues, trademarks, patents and other intellectual property, software license agreements and joint venture and strategic alliance agreements. Depending upon the industry, regulatory adherence, quality and quality control procedures will also be tested.
While many of the individual procedures are standard, the process needs to be customized for each transaction using flexibility to adjust the analysis based on available information, scope limitations, time constraints and results of the findings.
Virtual data room, data mining, artificial intelligence and other technology tools enable much of the work to be performed offsite and facilitates workflow, testing and analysis and easier completion while maintaining confidentiality, security and secrecy of the process.
Occasionally the findings impact materially on the terms of the transaction. Some common findings are understated or hidden liabilities such as pension obligations, product warranties and lawsuit claims, low quality of assets such as inadequate allowances for bad debts and non-saleable or obsolete inventory, reduced quality of the earnings such as where deferred sales are reported as current sales or some costs are capitalized.
Due diligence is an essential and involved process that needs care, focus, keen investigative, auditing and observation skills, and a thorough understanding of the target’s processes and accounting reporting. Due diligence techniques are also used in forensic investigations and can be employed in establishing preventative procedures.
This blog was adapted from a previous blog and article by Baskar Venkatraman, CPA, CITP, CFE, CISA, a due diligence specialist at Withum who can be reached at [email protected] and with assistance of James F. Weeks, CPA, Partner, Practice Leader – Transaction Advisory Services who can be reached at [email protected]. If you want to find out more about due diligence, you are welcome to contact me, Baskar or Jim.
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