For years, buy-side due diligence has been an important step during any merger or acquisition (M&A) process, mainly because it helps a prospective owner gain a complete picture of the transaction. This means taking a granular look at key factors that show the underlying health of a target business and its prognosis for future success. This includes:
Assessing the quality of earnings. This is typically a full review of financial, operational and strategic issues that directly influence corporate earnings. For example, a detailed review of gross profit margin by month, region, plant, product or even specific salespeople can reveal specific trends that disproportionally contribute to revenue and sales growth. Additionally, prospective buyers should look specifically for any negative adjustments to EBITDA (earnings before interest, taxes, depreciation and amortization). This might include the discovery of improper accrual accounting, incorrect classification of current versus long-term earnings, or inaccurate add-back adjustments made by management to help boost earnings.
Evaluating the seller’s assertions. While a quality of earnings assessment will help validate – or disprove – many claims made by sellers, it’s also important to examine a broader range of metrics to assess the total picture. Assume, for instance, that the seller claims to have a stable customer base. In that scenario, a closer look should show customer retention rates that are steady to improving, rather than evidence of recent slippage that may suggest future revenue problems. Similarly, if the seller notes that supply and distribution channels are working smoothly, careful due diligence will look for shipping backlogs, excess inventory or higher than average return rates that could hurt profitability.
Uncovering details that can lead to more favorable pricing. A critical component to the due diligence process is finding any evidence of current or potential target company liabilities that could carry over to new ownership. For example, unresolved state and local tax liabilities in various jurisdictions where the target company does business can become a significant post-sale expense for a prospective buyer. When due diligence uncovers these types of issues, it creates leverage for buyers, who can often negotiate more favorable terms or a better sale price for the transaction.
Please contact us for more information on due diligence processes or other business accounting issues.
August 15, 2017