Financial Due Diligence: What is Required & How to Prepare Your Business to Ensure a Successful Acquisition

So you have decided to sell your entire business, or a portion of it, and just received your first letter of intent from a potential buyer. Now it’s time to prepare for what many believe is a terrifyingly brutal process – due diligence.

There are several types of due diligence, including legal, financial, tax, operational, IT, human resources, and commercial—just to name a few. In this post, we will focus on the financial due diligence as that, along with legal, tend to be the most commonly executed.

Initial Requests

The due diligence process typically begins with an overwhelming list of requests which are expected to be provided in a short period of time. This is usually due to the time limitations of the letter of intent.

The time period of financial information typically requested tends to be the previous two fiscal years and the year to date information. The due diligence team may refer to the period of the “trailing twelve months” or TTM, which refers to the twelve month period ending with the more recent month of financial information closed.

Once the monthly trial balances are provided for this period, requests for schedules—especially relating to customer revenues and costs—are submitted which are expected to agree to the trial balances.

Each balance sheet account typically includes a number of requests of schedules and supporting documentation to prove the accuracy of the balance throughout the period. Trying to prepare these schedules just prior to the due diligence process can be very time consuming and will distract management from the day-to-day operations of the business.

Once all of the requests have been prepared, they are then stored on an electronic drive known as a virtual data room (VDR).

On-Site Visit and Meetings with Management

Once the data has been provided, the due diligence team will schedule a visit to your facility or offices. These meetings with management are often full-day meetings and may span a number of days to cover all of the questions and clarifications needed.

Typically, meeting agendas could include:

  1. Overview of the business operations
  2. Tour of the facility and introduction to certain key members of management
  3. Discussion regarding customer base, types of agreements, fluctuations of revenue by customer, revenue recognition, attrition of customers, concentration of customers
  4. A walkthrough of the entire trial balance, which includes questions on fluctuations of the balances on certain accounts, breakdown of items within accounts, and justification for the accounting method used. Through this process, the due diligence team is attempting to identify any unusual or non-recurring items, as well as any transactions that may not have been recorded or occurred but are expected to be incurred in future periods.
  5. Understanding of inventory and the accounting methods used
  6. Understanding any trends in pricing or future expectations for pricing
  7. Determining whether all liabilities have been properly recorded
  8. Understanding headcount and related payroll expenses and other benefits that employees may currently receive which they would expect to continue to receive, as well as committed employee contracts that may include acquisition related bonuses
  9. And many other topics…

The on-site process can be grueling for a company as the due diligence team usually requires the attention of the more senior or experienced employees – the ones that are often also integral to keeping the company’s operations running. Preparing these individuals is critical to ensuring the process is as efficient as possible. Furthermore, if the management team is able to answer all the due diligence team’s questions thoroughly and clearly, they will avoid multiple follow-up questions.

Final Report and Negotiation

When the due diligence team leaves your facility, the expectation is that they will review all of the information provided in detail and communicate any additional inquiries. They will then complete their report and provide it to the buyer. The buyer will then use the results in the report as a negotiating tool when determining the purchase price or other key terms in the purchase agreement.

The Risk of Not Being Prepared

By now, it should be clear that being properly prepared for the financial due diligence process is critical to the completion of a successful acquisition.

Business owners who are distracted by requests for financial information can lose sight of the negotiation process and not receive the greatest value possible for their business.

Furthermore, if the financial information is considered disorganized, not accounted for properly, or not supportable, the buyer could infer that the results provided may not be an accurate depiction of the business. The buyer will see this as an additional risk and discount the potential purchase price as a result.

Prepare Your Business for the Financial Due Diligence Process

Signature Analytics has supported several companies through the acquisition and financial due diligence process. We will make sure that your financial records are accurate and maintained in a timely manner prior to the start of the due diligence process, as well as help prepare supporting schedules and documentation requested by the due diligence team. We can also put together a sell-side due diligence or quality of earnings report so you’re fully prepared for the financial due diligence process. Contact us for more information or a free consultation.

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