RSM Tenon on the importance of due diligence
IT is likely that all of us at some stage in our lives will be sold a "dud" or will make a purchase which will not meet our expectations.
The extent of the resulting outcome can differ enormously, ranging from mild irritation to complete disaster. Unfortunately, the same is true in business.
The risks involved in making a corporate acquisition, whether of a large asset, a division of an existing company, or even a competitor, are enormous because there are so many unknowns to consider.
Buying a business is a challenging, yet potentially rewarding, process and can take months to complete. It will involve investing a significant amount of money and time and it is therefore critical to do your homework when gathering information about the business you intend to acquire – referred to as due diligence.
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Depending upon complexity, you will generally use specialists in due diligence to investigate the background of the target company.
The results may be prepared in a due diligence report, enabling you to understand the risks involved in the acquisition. The value of using specialists is that it not only provides you with a "trained eye" to undertake rigorous checking, but that it also provides a dispassionate view of the target company.
When selecting your due diligence provider, you should opt for specialists who are dedicated to the owner-managed and private market and who are opinionated in their reporting.
The following areas are typically examined during the due diligence process:
Finances – financial due diligence is one of the most critical investigations and a failure to properly examine the target company's books and records could result in you taking on a significant financial liability. Financial due diligence should normally include an analysis of the target's profitability and cash flows (present and projected), its accounting methods, its tax affairs and a review of the balance sheet.
Commercial – while the financial issues may have been accounted for, there are still many pitfalls if you ignore the commercial risks. Review your target's markets, its competition and its supplier and customer base.
Management and staff – review key employees' skills, experience, wages and salaries, payroll procedures and other relevant human resources issues such as over-dependency on key staff.
Pensions – a number of recent high-profile transactions have failed due to the existence of large deficits in final salary pension schemes. You should consider appointing appropriate specialists to consider the existence of pension deficits and, if necessary, provide an estimate of the quantum of contribution to eliminate the deficit.
Property/equipment – you should review all appropriate leases and/or deeds and conduct appraisals for all equipment and assets.
Conducting proper due diligence will help you mitigate potential problems such as:
Misunderstandings as to the type and condition of the business being bought.
Poor financial situation.
Contingent liabil- ities.
Declining markets or over-reliance on suppliers/customers
Under-funded pension schemes
Poor state of assets or onerous lease terms
Good due diligence can often enable a better price for the target company to be negotiated. In our experience, over a quarter of deals on which we have performed due diligence are renegotiated (and in some cases aborted) following the due diligence process.