Pre-Acquisition Due Diligence

Date: March 1, 2011

Written By: Jeff Gillesse

There are many risks associated with the acquisition of a business, whether the acquisition is strategic or financial in nature. Typically, an offering memorandum or prospectus is prepared by the seller or a third party such as an investment banking firm. This document would contain valuable detailed information about the company, its past performance, and expected future metrics. This is akin to a profile in an on-line dating website, where fundamental information sparks interest by the other party. However, the process that follows in vetting the candidate can and should be much more substantial. One of those processes in the business acquisition cycle is dubbed “due diligence”. Generally, the prospective buyer of a business will contract a significant portion of the due diligence process to an outside firm, that will provide its findings to the buyer to be used in validating the purchase price or modifying it as the buyer sees fit.

Accordingly, since the due diligence process is a very important tool in understanding the business and all related risks, it is imperative that the party selected to conduct this work be well qualified, and the process should be viewed as much more than a compliance exercise. The highest value to be delivered in the process would be when the firm is capable of seizing the opportunity to enhance the target’s post-acquisition value through recommending the implementation of specific best practices as the firm’s experience may suggest.

Due diligence processes should be customized based upon the specific objectives conveyed by the buyer, but should include:

• Comprehensive analysis of financial data, operation metrics, and other reports
• Assessment of systems, infrastructure, controls, management qualities and capabilities
• Review of operations and all ancillary processes
• Analysis of assets being acquired, including observations on the condition of equipment, manufacturing environment, and related cost structures
• Review and commentary on inventory composition, valuation considerations, and cost inclusion in bills of materials
• Review of customer credit underwriting policies and practices
• Review of liabilities, which may include tax considerations, contingent issues, threatened or pending litigation, trade payables, leases, loan agreements, and relationships with vendors and other creditors
• Assessment of sales policies, sales team, compensation practices
• Review of IT systems, software, website, portals, and relating licensing
• Review of Human Resources policies, compensation, benefit programs, and the like
• Analysis of the company’s marketplace, product longevity, competition, etc.
• Review of accounting and tax considerations in establishing asset and liability bases, exposure to tax liabilities, and potential encumbrances to free and clear transfer of title to assets
• Development of financial forecasting model(s) to validate purchase price and terms, determine return on equity, future cash needs, and for future use as a decision-making tool
• Identification of risks and strategies to manage risks through the acquisition transition period
• Review of financing terms and loan covenants to ascertain reasonableness when compared to forecasted metrics
• Collaboration with legal counsel engaged by both the buyer and seller to minimize the potential for conflict and the resultant expense
• Development of a realistic closing schedule, along with various supporting schedules for the purchase agreement
• Assist in the development of the short-term post-acquisition tactical plan

The aforementioned list is a sampling of the tactical steps that may be undertaken in performing the work; a comprehensive list should always be developed upon the engagement of the firm and the scope of work negotiated with the buyer, agreed to between the parties, and put into a written agreement.

Level Ten’s extensive collective experience in mergers and acquisitions, managing turnarounds in a crisis situation, finance and accounting, as well as hands-on operation of various enterprises make it an excellent choice for conducting due diligence in an acquisition. Throughout the course of the due diligence exercise, Level Ten also makes recommendations to the buyer on ways to optimize economic performance as those opportunities are discovered. In the event the buyer wishes to engage Level Ten in post-acquisition interim or transition management or the execution of a turnaround strategy, we are in the best position, having gained a complete understanding of the business specifics, to proceed in that capacity. Our experience in working in the distressed and crisis business arena is foundational to providing the best possible outcome for all parties.

If you would like more information about pre-acquisition due diligence or transition management, please contact us at info@leveltengroup.com or call Jeff Gillesse at 616-893-0366.