A detailed well executed due diligence is a necessary pre-requisite for a well-planned acquisition. This however, is just one part of the equation. There are several others, the confluence of which should fall in sync in order for those identified synergies to come to fruition.
M&A practices and procedures have evolved over the years and it is often the case that electronic data rooms provide plethora of information & transparency. Secure content management, collaboration solutions enable exchange, control, and management of information between organizations through their virtual data room and deal space solutions. Remember, the acquisition process is intended to be rapid, smooth and yet detailed, all encompassing and onerous.
The Internal Control standards (SOX) ushered in era of new requirements for governance and conduct to public company boards, CFOs and CEOs requiring certifications, reporting requirements and non-compliance penalties. The Committee of Sponsoring Organizations of the Treadway Commission (COSO) requirements has further asserted the top-down risk based approach. The pervasive need for controls has caused the M&A due diligence to get more in-depth, deeper dives in to financial reporting issues, verifiability and validation. Large M&A transactions attract government enforcement and regulatory requirements and public scrutiny. However, I have limited my attempt to providing some insight in to how due diligence is both an art and a science that follows a certain steps or processes. Due diligence is getting increasingly creative and strategic, given that most M&A deals have a strategic intent.
The thought of M&A due diligence often times conjures up formal review of key contracts, representations, warranties (rep wars) and such corporate documents. However, it should go deeper than that in to the values, culture, history, mission and intangible assets of the company. As a valuation consultant, I recently witnessed how a business was forced to write down millions of dollars from their Balance Sheet barely about a couple years after post-closing, as the metrics that were assumed at the time of acquisition simply were not visible in the first quadrant, instead some of the strategic costs advantages were anything but. M&A process involves some serious hours of work from lawyers, accountants, investment bankers, industry specialists and strategy consultants – depending on the size of the deal, complexity and wherewithal of the entities involved.
Due diligence should be a realistic test to assess whether the underlying assumptions driving the deal to both parties are reasonable or illusory. Cross-border acquisitions in the global M&A marketplace heightens the need for the buyer to perform a proper regulatory due diligence.
The due diligence work is two fold: financial – analyzing strategic costs – ‘As Is’ and ‘To be’ states, factoring in transaction costs, value accretion and myriad other relevant financial metrics and strategic intents – generally a futuristic state on how the acquirer may benefit by the transaction, which should dovetail with the long term vision of the enterprise. In economic terms, these could be anything from economies of scale to a global footprint with access to newer and enlarged markets with immense growth possibilities and synergies. Management Accountants play a critical part in analyzing and articulating whether or not the proposed transaction is viable. The M&A transactions should focus on pitfalls that could push post-closing metrics with negative trend lines to the top of the heap.
A few quick pointers to the process:
1. Include broad rep-wars and liability holdbacks, and indemnifications in the purchase agreement.
2. The seller negotiates for carve-outs – limiting liabilities before the buyer may seek reimbursement for undisclosed or unexpected liabilities.
3. A rational approach would be not to get too involved in minutiae instead focus on the big picture. The key is to confirm factual assumptions and enterprise valuation underlying the terms based on which the buyer negotiates the deal. If the risks and liabilities outstrip the perceived benefits of the transactions, it is worthwhile to walk away from it all.
4. Ask the right questions at the appropriate time and to create trust and urgency in the seller to make full disclosures.
5. Prepare comprehensive and customized checklists of the specific questions, maintain methodical system for organizing and analyzing the documents and data provided by the seller, and quantitatively assess the risks raised by those problems discovered in the process.
6. What are the obligations that the buyer would be required to assume post-closing – stock purchase; asset purchase: define liabilities assumed and identify few successor liabilities that cannot be contractually avoided: for e.g.; leases.
7. Third-party / regulatory agencies approval requirements.
8. Financial: incremental cost of debt, equity dilution, current market cap versus implied valuation post-closing.
9. Due diligence is neither a hasty one to save costs / appease the seller, nor is it a tedious fishing exercise.
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