Financial due diligence for an external consultant in a business sale environment is a two-sided coin, and to use a cricketing analogy as an accountant, you are either a batsman or a bowler, the aims of your role are very different but there is an appreciation of that the other has a job to do. Being an allrounder is even better as you probably get a more rounded appreciation of the game.

The Batsman (the role in selling) , prepares well, looking to deflect awkward questions and respond on the front foot trying to achieve a high score and be successful.

When a company is up for sale it needs to show an in-depth report on its financial health to potential buyers. The company will want to show its performance in the most positive way, but this must be supported by evidence and well-documented information as this is going to be challenged by the financial due diligence of the buyers. In order to get this right, good planning is required and working alongside company management and other advisers, ensure that opportunities and issues are understood, and that potential issues are addressed at the earliest opportunity.

If done well it provides vendors with greater control over the sale process and the timing of sale, which can, in turn, help secure a higher price for the business.

The benefits of financial due diligence are not limited to the acquiring party. For the target company, the financial due diligence report paints a clear picture of their key strengths and weaknesses. This in turn allows them to be sufficiently equipped for probing from the buy side. In such cases, responses are put forward in advance to speed up and keep control of the negotiations.

A well-planned finance DD for a sale may;

·        Provide vendors with greater control over the sale process and the timing of sale, which can help secure a higher price for the business

·        Reduce disruption to the business as the sale process is more controlled

·        Help add credibility to the facts, figures and information provided in the sales memorandum

·        Remove the necessity for a buyer to have substantial access to do their own due diligence work as they will be able to rely on the vendor due diligence report

·        Vendor assistance specialists can ensure that the vendor retains pace and initiative throughout the sale process

·        Early identification of value critical issues, providing the option to "regroup and fix".

·        Reduces uncertainty risk for finance buyers, potentially justifying higher offers

This is the vendor due diligence.

For many small businesses they may only sell a business once and therefore do not have experience of the wider process. In one of the first deals that I ever worked on this was the case, and the business involved simply went to an Agent who had the company that I worked for already lined up as a potential buyer. The Agent simply did the introduction, had met the vendor twice and had no more than the last 2 years statutory accounts to hand. The business was in no way well prepared for sale, and certainly had not been packaged in order to maximise consideration. I found this quite puzzling at the time, as if the business had been better prepared with good sales due diligence, I think a price of some 25% more than the final sale price could have been achieved quite easily.

Whilst reflecting post completion with a more experienced colleague he simply said to me, “Well it’s simply a case of the partially sighted leading the blind”, and those words are so true.  Being well prepared has no guarantees but if nothing else it improves the odds.

 

The Bowler (the role in buying) , trying to suss out the opposition and look for weaknesses in the defence.

Financial due diligence is the procedure a potential buyer of a company undertakes to assess the financial health and stability of the assets up for sale. The assistance is to provide transparency and comfort to the acquiring party, financial information is scrutinised and any mitigating circumstances or areas which could potentially pose a risk are highlighted. It is not necessarily advising on if the deal should be done or not but provides information for a decision to be made, as well as evidence to help any negotiations with regards to price or the structure of the deal.

Financial due diligence is a crucial part of the acquisition process which enables parties to make informed decisions relating to the purchase.

Once the acquiring party has reviewed its own business strategy about instigating an acquisition, the following process is initiated before negotiations on the sale begin:

·        The buyer formally expresses its interest in acquiring the target company

·        Both parties conduct initial discussions on purchase terms

·        Outline terms are established, and following this both parties are then required to sign confidentiality agreements

·        Financial due diligence work begins once the target company provides related materials to the buyer

·        Forecasting work can be carried out to look at the post acquisition issues of the larger enterprise and highlight potential challenges with regards to business integration.

 

Financial Due Diligence Benefits

The main benefit of a financial due diligence report is for the buyer to establish an understanding of historic and actual financial performance, as well as forecasting its financial solvency. The result of which allows for an informed valuation of the company.

Apart from the main objective of underlining any financial or tax risks, financial due diligence also has the advantage of providing buyers with an understanding of the target company’s assets, liabilities, and operations management structure. When combined with other forms of due diligence, a solid basis is established for informing strategic investment decisions related to the acquisition.

 

Financial Due Diligence Checklist

The financial due diligence report is a comprehensive document outlining the findings from a third-party. The contents vary between industry; however, contents found in a report that will cover:

Profitability and Sustainability

·        Review historical financial documents.

·        Review of financial policies, asset quality and profitability as well as the roles of key staff and their role and terms post acquisition.

·        What is the financial structure of the target company?

·        What is their current credit situation and current contractual situation with regards to ongoing work?

·        Questions relating to motivation of target company’s acceptance of acquisition.

·        Highlight the risks and challenges around post acquisition trading and business integration.

·        Identification of possible synergies for the combined business.

·        Impact of any restructuring in the post completion period.

·        Any organisation considering a deal needs to check all the assumptions it is making about that deal. Financial due diligence provides peace of mind to both corporate and financial buyers, by analysing and validating all the financial, commercial, operational and strategic assumptions being made. It uses past trading experience to form a view of the future and confirms that there are no 'black holes'.

·        The components of the service are revenue and market due diligence, synergy validation, maintainable earnings, future cash flows and all operational issues, as well as deal structuring.

 

Financial Forecasting

·        Forecasts of earnings, cash flow and capital requirements for both the target company and the combined group post acquisition. This will involve extensive work not only on the target company but a good understanding of the acquiring business.

·        Evaluation of the impact of interest and exchange rates, where appropriate, as well as potential tax changes and a regard for an outlook for that industry.

 

Internal Control

·        How is the target company currently being operated? (people, systems and IT)

·        What financial procedures are currently in place?

Tax Affairs

What is the current tax status of the business and are all tax matters up to date? This will normally be reviewed by a taxation specialist who will make sure all documentation in the final sales agreement is covered with all the necessary guarantees.

 

How can the external consultant help?

Sometimes strategic decisions are made at a high level in the business that an acquisition should be made. The danger is that it can be difficult for internal sources to go against this even if on an informed basis. The external consultant can challenge and provoke discussion on an informed basis if they have a good understanding of the sector and the operational challenges that it faces.

The process helps combine comprehensive information and an intuitive set of features that allow any team to uncover opportunities and understand risks.

 

 

Phil Talbot is a Chartered Accountant and Business Consultant, specialising in the provision of business and accounting advice for small business offering part-time FD services.

With over 28 years in Senior Finance roles including 16 years as Finance Director in one of the UK’s largest and most successful Social Care Businesses he has specialist knowledge and experience of the Health and Social Care Sector.

For more information please contact phil.talbot@pjtconsultancy.co.uk

Phone: 07967 640082