The pace of transactions is getting faster in a more complex and challenging M&A environment, leaving large corporates, SMEs, entrepreneurs and financiers with limited time to make critical decisions. This must rely on a comprehensive assessment process before completing any deal. Why is due diligence considered as one of the essential steps leading to the success of any M&A transaction?
Every M&A transaction is unique and comes with its specific challenges: the target may be a business division of a multi-jurisdictions group whose financials do not match any pre-existing financial reporting or a domestic privately-owned company with a simplistic approach to business performance analysis although it operates in a complex industry. It might also be a private equity fund considering the possible exit for one of its portfolio companies.
These are typical situations where due diligence, either buy-side or sell-side, will help maximise the value for the buyer and seller through the involvement of seasoned financial and tax professionals who will bring their expertise and local market knowledge to reach facts-based decision. This article focuses more specifically on buy-side due diligence.
By the way - what is a financial and tax due diligence?
A due diligence is not another check list whose sole purpose would be to tick a box and move to the next stage of the transaction workflow. It is at the heart of a transaction and addresses a broad range of topics (financial, tax, legal commercial, operational, human resources, technical, corporate social responsibility, IT), depending on the complexity of a target and the needs of a buyer.
It is thus tailored to match the context of a particular transaction, although some workstreams are systematically addressed due to their key impact on the financial terms of a transaction. Being one such workstreams, a financial and tax due diligence aims at providing all the necessary information, analysis and expertise to:
- confirm the key metrics of a deal (usually shared with limited level of details at the preliminary stages of discussions between the parties) and,
- identify any other risks and opportunities that derive from the involvement of professionals familiar with the market and the industry.
A due diligence is not a mandatory requirement per say, but in practice, it has become an essential component of any M&A transaction, irrespective of the deal size, industry or geography.
What can be expected as outcomes of a due diligence?
Advanced valuation techniques and structures are used when assessing and building deals, but in most cases, these rely on selected financial aggregates combining historical financials (audited or not) and management forecasts. The outcomes of a financial and tax due diligence will help confirm that the levels of profitability, the definitions of the financial aggregates and the drivers of the target business are fully understood and aligned with what was initially represented by the seller. Such conclusions are achieved, using a combination of financial analysis, business model assessment and tax expertise.
Any findings of such process led by experienced professionals will likely result in adjusting some of the initial assumptions supporting a deal leading to adjustment upwards or downwards of the transaction value: the financial due diligence will focus on the quality of earnings (i.e. what is a normative profitability for that business), the level of net debt and the required level of net working capital necessary to run operations.
Experience shows that such conclusions would have likely not been reached without a proper due diligence process that enables access to more detailed and extensive information, combined with interactions with the management of a target company.
On top of the immediate valuation component, the findings of a financial and tax due diligence will help identify and assess any confirmed or potential risks (undeclared tax exposure due to a simplistic analysis of a commercial tax set-up in an overseas jurisdictions, employee-related obligation, impact of the loss of a major customer) to ensure that the legal documentation of the deal is accurately taking into account all such contingencies.
Finally, this in-depth review of operating flows, internal organisation, systems, financial reporting, etc. is frequently used internally by buyers to prepare for the future integration, including with the involvement of experts in post-merger integration (who be sharing knowledge with the due diligence team to ensure continuity and efficiency beyond the completion of a deal).
To conclude, the value of any due diligence depends on the objectives of a buyer. Our experts are here to help design and conduct the due diligence that will help you achieve this goal.