Tips for a thorough due diligence process when acquiring or selling a business
When acquiring or divesting a business, being thoroughly prepared for the due diligence process can significantly simplify the process. To ensure a simplified process, below are a few of the areas that need to be investigated, alongside warning signs that should sound alarm bells. Let’s investigate the top tips for a thorough due diligence process.
In a due diligence process, it is important to look into the past financials of a company over at least 3 years, whilst investigating and understanding the causes of any significant changes in revenues or expenses. In undertaking this process, it’s also necessary to ascertain when significant capital expenditure is required, and the intricacies of the business; such as changes in profit margin trends. You should also understand the actions that have previously been positive or detrimental for the business, thus enabling the greatest level of success upon acquisition.
It is vital to delve into the adjusted EBITDA, most recent financial accounts and customer lists. EBITDA can be subjective, thus if once you’ve investigated the add-back schedule you have a significantly different profit, it should raise concerns about the legitimacy of the deal. If the sale process is ongoing for some time and a business is reluctant to release updated financials, it may indicate that the business performance is in decline.
Understanding the company’s expenditure on marketing, their placement in the market and the strategies that have been implemented to achieve this position, is significant in the due diligence process. If you are a strategic buyer, synergies can be maximized by assimilating marketing strategies or keeping them differentiated, but it is still crucial to understand your target’s position in order to maximise the benefits of the acquisition or merger.
The major concern is if the company has reduced their marketing team or expenditure on marketing leading up to the divestment. This will lead to problems with acquiring customers and even maintaining existing customers post acquisition, and also signals a lack of intent from the current owner to assist once ownership has been transferred. Risks such as this can be minimised through having the owner continuing to work in the business on a consultancy basis.
When investigating this aspect, discover how many customers the company has, and the percentage of sales concentrated on each customer. It is important to try and understand each customer’s motivation, their goals and how the business you are acquiring can assist in achieving these in the future.
If a business has a low number of customers or a high concentration of revenues coming from one or two customers this should create significant concern and as a buyer you should be offering a lower profit multiple. You should also be concerned if a new customer has generated a significant portion of revenue for only a year or two. If the owner is now divesting, they may be uncertain of maintaining this customer into the future.
Beyond the organisational chart, it is necessary to look at bonus schemes and compensation strategies such as leave, the use of cars, and any similar strategies the owner may be implementing to ensure staff morale is maintained. Of significant importance is also understanding management’s views on how the business could be improved and how they envisage their careers progressing in the future. An entrepreneurial seller may wish to take their best managers to their next venture.
High staff turnover and a history of resistance or lack of experience from management in implementing change can create a number of issues for acquirers taking over a business. On top of this records should be kept of previous staff disputes. Disputes are common in the work place and if the owners are withholding this information when asked, it should create some concern.
If you would like help with respect to Due Diligence, contact our team of mergers and acquisitions experts by calling us on 1300 QUINNS or alternatively, +61 2 9223 9166 to arrange a teleconference or appointment.