The benefits of financial due diligence

Buying a business is expensive; both in monetary terms and in the management time required to execute a deal. However, as Corporate Finance partner David Holt explains, the time and investment spent on financial due diligence can be insignificant compared with the cost of dealing with issues that should have been identified, and dealt with, before completing an acquisition.

What is due diligence?

Due diligence is a purchaser’s opportunity to scrutinise the target business before acquisition. It takes many forms, including:

• Financial;
• Legal;
• Operational;
• Commercial;
• Technology;
• Insurance; and
• Management.

This list is non-exhaustive and there will be others. Not every area applies to every acquisition, but both financial due diligence and legal due diligence will be common to virtually all deals.

Unsurprisingly, as chartered accountants, our primary focus and concern is the financial status of a business our client is planning to buy or sell. 

What is financial due diligence?

Financial due diligence is an independent investigation into a business’s finances and will typically include looking into areas including:

• Understanding the roles, responsibilities and structure of the finance team;
• An assessment of the Management Information (MI), MI reporting process and the quality of MI prepared;
• An assessment of the suitability of accounting policies, including compliance with Accounting Standards;
• Understanding trends in historic financial performance;
• A detailed balance sheet review, including an assessment of the working capital needs of a business and the level of net cash/debt;
• An assessment of taxation compliance and reporting; and
• A review of the reasonableness of the assumptions underpinning projected financial performance.

In many cases, a key objective is to confirm the facts and figures on which an offer was made and accepted. Financial due diligence is therefore key to understanding the structure and will support the commercial negotiations and the drafting of the legal agreement.

What are the benefits of financial due diligence?

There are several benefits to performing financial due diligence.

• It confirms the basis on which an offer was made;
• It can identify issues that can lead to a renegotiation of the deal structure, and potentially the headline price;
• It can identify issues that need to be dealt with in the form of indemnities or warranties;
• It should support negotiations surrounding normalised net working capital and net debt positions;
• It helps to identify (and hopefully manage) financial and commercial risks;
• Helps the acquirer develop a list of priorities to be addressed in the post-acquisition period; and
• Can save significant amounts of management time post-transaction.

Communication is key to a successful financial due diligence process – both with the vendors and the purchasers. This ensures that any issues and identified and dealt with in a constructive and open manner.

When performed properly, financial due diligence can add a significant amount of value to an acquisition process. By providing purchasers, and vendors, with extensive and actionable information financial due diligence contributes to a fair valuation of the target business.

It is therefore essential that sufficient time and budget is allocated to financial due diligence and other due diligence processes. In our experience, post-transaction surprises are rarely good news!

Adding value to your acquisition through financial due diligence

Since it was established in 2013, Consilium has undertaken hundreds of financial due diligence projects for corporate clients, banks, venture capital and private equity firms. With a customer base composed primarily of owner-managed businesses we, therefore, have significant expertise in the execution of small and medium-sized business transactions.

If you are considering buying, selling or investing in a business please contact David Holt to arrange an informal virtual or in-person appointment.

About the author

David Holt has over 30 years of experience in Corporate Finance and Audit, with a focus on transaction services. A veteran of Arthur Andersen, Deloitte and RSM Tenon, David is one of the founding partners of Consilium Chartered Accountants.

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