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Due Diligence in Mergers & Acquisitions

The primary goal of due diligence is to collect as much information as possible about an opportunity and ensure that it is a legitimate opportunity. If the target company, for example, turns out to be a fraud, then the diligence process was not successful.

Its ultimate purpose is to help decision making on whether or not to proceed with the deal. The financial due diligence process and team assigned will vary depending on how much risk there is (and therefore how much money will be at stake) and what stage of development the deal is in.

The process is usually managed by the financial due diligence team, which is part of the legal or acquisition team.

The following is an overview of the financial due diligence phase in M&A.

Some investors may not carry out any form of due diligence before acquisition, especially for smaller-dollar acquisitions. This can be risky, as they are often acquiring a company without fully understanding how it makes money or what its true value is. Although this approach makes it faster to make a decision, there are two possible problems:

  1. If no due diligence is carried out before acquisition then the new owners assume that they are buying a profitable company for cheap … which is seldom the case.
  2. If they do carry out due diligence and discover that the company is not profitable, they may be forced to write down goodwill, change capital structure or restructure the business. This could result in large income tax liabilities for them or worse, bankruptcy.

To avoid these problems most investors will usually do some form of due diligence before finalizing an acquisition.

Financial Due Diligence Process

The financial due diligence process is designed to collect as much information as possible about the target company, its customers and suppliers, accounts receivable balance, pricing trends and so on. The process is designed to find problems that could affect the business or deal. It is not to find problems that are already known or that can be factored into the price.

Investors (and banks) will usually appoint an audit team (which may include lawyers, accountants, IT professionals and analysts) to carry out financial due diligence for them. These professional fees are included in the overall transaction cost.

The objective of financial due diligence is to understand how the company makes its money (its revenue streams), where all its assets are (to ensure there is no hidden debt), whether its cash flow is strong enough to repay debt, whether it has any tax issues and so on.

In order to do that the auditors will look into the following areas:

  1. Accounts receivable and payable – It is important to understand how much money is owed to customers and how much to suppliers/vendors. In most countries, companies must prepare a monthly statement for their customers detailing amounts due from them. This information should be accurate and include supporting documents such as evidence of payments received. Failure to do this can result in a breakdown in trade relations with a customer, causing financial difficulties for the company.
  2. What can be easily shown must really be what you have – the team will also look into the asset side of the business. They check that all buildings, vehicles, machinery and equipment are owned by the company. If they are being leased then there should be a legally binding contract to do so. If none of these assets are owned by the company, any cash tied up in them is at risk because they could be repossessed by lenders or lessors at any time without warning or consultation with management.
  3. Security provisions – all fixed assets should have title insurance policies in place to protect against fraud and theft … but too often, these policies are not renewed on time, if at all. It is a good idea to check that property is insured and that the insurance policy has been renewed.
  4. What is the value of receivables? – all accounts receivable should be reviewed for accuracy. Loans from related parties should be verified since they may not have been repaid in full, or at all. Any loans from customers should also be evaluated on a case-by-case basis to determine whether they exceed the normal terms offered to other customers or whether there are any additional collateral requirements on them (for example, car loans that require cars as collateral).
  5. All payments made to employees and all expenses and payments for capital expenditures must be verified and reconciled. This also includes payments to other companies as well as costs associated with leases and trust deeds.
  6. Critical ratios – the auditors will assess the business’ financial health based on its key ratios, such as EBITDA (earnings before interest, taxes, depreciation and amortization) and cash flow.

When the first financial analysis is completed, you should receive a draft valuation analysis and should discuss it with your lawyers, accountants or trusted advisors to ensure that they are comfortable with it. You may need to make some adjustments or provide additional information before signing any documents for due diligence approval.

If any issues are found during the financial due diligence process they are usually addressed in detail during closing documentation discussions.

Closing the Deal

Once all the financial due diligence is complete, when it appears that there are no more problems with the target company, final negotiations may begin. At this stage, valuations are running around two to three times EBITDA (earnings before interest, taxes, depreciation and amortization).

The most important thing you must remember when negotiating this stage of the deal is that no deal is final until all documents are signed. This means that all terms of any agreements in place in the financial due diligence phase will be in place during closing unless you can negotiate an agreed version with your lawyers or advisors.

If you do not have a lawyer, you should find one who has experience in acquisitions and be sure to discuss the issues with them at every stage of the deal because no two situations are ever quite alike.

Hire the best Due Diligence specialists in 2,900+ industries

Fintalent is the invite-only community for top-tier M&A and Strategy talent. Hire global Due Diligence consultants with extensive experience in over 2,900 industries. Our platform allows you to build your team of independent Due Diligence specialists in 48 hours. Welcome to the future of M&A!

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Frequently asked questions

Most frequent questions and answers

What clients usually engage your Due Diligence Consultants?

We work with clients from all over the world. Our clients range from enterprise and corporate clients to companies that are backed by Private Equity or Venture Capital funds. Furthermore, we work directly with Family Offices, Private Equity firms, and Asset Managers. Most of our enterprise clients have dedicated Corporate Development, M&A, and Strategy divisions which are utilizing our pool of Due Diligence talent to add on-demand and flexible resources, expertise, or staff to their in-house team.

How is Fintalent different?

Fintalent is not a staffing agency. We are a community of best-in-class Due Diligence professionals, highly specialized within their domains. We have streamlined the process of engaging the best Due Diligence talent and are able to provide clients with Due Diligence professionals within 48 hours of first engaging them. We believe that our platform provides more value for Corporates, Ventures, Private Equity and Venture Capital firms, and Family Offices.

Our Hiring Process – What do ‘Community-Approach’ and ‘Invite-to-Apply’ mean?

‘Invite-to-Apply’ is the process by which we shortlist candidates for the majority of projects on our platform. Often, due to the confidential nature of our clients’ projects, we do not release projects to our whole platform but using the matching technology and expertise of our internal team we select candidates who are the best fit for our clients’ needs. This approach also ensures engagement with our community of professionals on the Fintalent platform, and is a benefit both to our clients and independent professionals, as our freelancers have direct access to the roles best suited to their skills and are more likely to take an interest in a project if they have been sought out directly. In addition, if a member of our community is unavailable for a project but knows someone whose skill set perfectly fits the brief, they are able to invite them to apply for the role, utilizing the personal networks of each talent on our platform.

Which skills and expertise do your Fintalents have?

The Fintalents are hand-picked and vetted Due Diligence professionals, speak over 55 languages, and have professional experience in all geographical markets. Our Due Diligence consultants’ experience ranges from 3+ years as analysts at top investment banks and Strategy consultancies, to later career C-level executives. The average working experience is 6.9 years and 80% of all Fintalents range from 3-12 years into their careers.

Our Due Diligence consultants have experience in leading firms as well as interfacing with clients and wider corporate structures and management. What makes our Due Diligence talent pool stand out is the fact that they have technical backgrounds in over 2,900 industries.

How does the screening and onboarding of your Due Diligence talent work?

Fintalent.io is an invite-only platform and we believe in the power of referrals and a closed-loop community. Members of our community are able to invite a small number of professionals onto the platform. In addition, our team actively scouts for the best talent who have experience in investment banking or have worked at a global top management consultancy. All of our community-referred talent and scouted talent are subject to a rigorous screening process. As such, over the last 18 months totaling more than 750 hours of onboarding calls, of which only 40% have received an invite-link after the call.

What happens if I am not satisfied with my Due Diligence consultant’s work?

During your initial engagement with a member of our Fintalent talent pool with no risk. If you are not satisfied with the quality of your hire for any reason then we are able to find a replacement at short notice. There is no minimum commitment per project, but generally projects last at least 5 days and can last 12+ months.

Interested in our invite-only community of tier-1 Due Diligence experts?

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