Due diligence is a fundamental element of every M&A transaction and is typically carried out by an advisory firm on behalf of the buyer or the bank funding the transaction.
Preparation is key to ensuring that the seller comes out the other side unscathed as the experience can often be painful if the initial financial and commercial information exchanged prior to agreeing outline terms doesn’t stack up with that provided during the detailed due diligence phase.
The seller is openly inviting a “chip” if there are inconsistencies within information or a lack of supporting data and explanations. The message to sellers is therefore the classic “fail to prepare or prepare to fail” scenario!
Likewise, the buyer or the funder want to corroborate their views of the company and ensure that risks are highlighted and sensitivities, where possible, quantified. External professional advisors are appointed to perform the due diligence exercise and then report back on their key findings. These advisors have the twin benefit of being independent of the outcome of the transaction and will bring their objectivity and experience in carrying out these specialist assignments to a transaction.
The due diligence scope will vary from business to business and from transaction to transaction. However, almost every scope will focus on “quality of earnings” and include a review of the company’s working capital requirements. In addition, a bank will always want the scope to include a review of debt serviceability.
The composition of the customer base of the seller will also be important – due diligence will review and analyse any concentration issues, the company’s competitive position and highlight potential issues such as customer warranty claims and off balance sheet liabilities.
The seller’s goal is to exit the due diligence phase without any “chip” to the terms of the transaction, however, there are some canny buyers who see the exercise as “open season” to identify issues that can affect the purchase price, or structure of the deal, and lead to the initial offer being revisited.
The role of advisors such as Lexington is to manage and undertake the due diligence process for either the buyer or the seller bringing with it our own diligent approach to Due Diligence.