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

So you have decided to sell your business, and you’ve received your first letter of intent from a potential buyer, exciting! Now, it’s time to prepare for what many view as a terrifyingly brutal process – due diligence.

There are several types of due diligence, including legal, financial, tax, operational, IT, human resources, commercial, and more. In this post, we will focus on financial due diligence as it’s one of the most commonly executed forms.

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 timeframe is usually due to the time limitations of the letter of intent.

Financial information is typically requested for the year-to-date and the previous two fiscal years. If the due diligence team uses the term “TTM,” they are referring to financial records for the 12 month period (or Trailing 12 Months) which ends with the more recent month.

Once the monthly trial balances are provided, there will likely be requests for schedules, such as ones that relate to customer revenues and costs. Once those are submitted, they should agree with the trial balances.

Each balance sheet account typically includes numerous requests for supporting documents to prove the accuracy of the balance throughout the period. Preparing these just before the due diligence process can be very time consuming and can 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 often take multiple 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 introductions to key members of management.
  3. Discussion regarding customer base, types of agreements, fluctuations of revenue by customer, revenue recognition, attrition of customers, and concentration of customers.
  4. A walkthrough of the entire trial balance. Questions may be asked on fluctuations of the balances on certain accounts, breakdown of items within accounts, and justification for the accounting method used.
  5. Throughout this process, the due diligence team is attempting to identify any unusual or non-recurring items, and any transactions that may not have been recorded or occurred but are expected to be incurred in the future.
  6. Understanding of inventory and accounting methods.
  7. Understanding any trends in pricing or future expectations for pricing.
  8. Determining whether all liabilities have been properly recorded.
  9. Understanding headcount, payroll expenses, and other benefits employees currently receive, as well as committed employee contracts that may include acquisition-related bonuses.
  10. And many other topics – so be prepared!

The on-site process can be grueling for a company. The due diligence team usually requires the attention of the more senior or experienced employees, the ones who are integral to keeping the company’s operations running. Part of the preparation process will be helping these individuals on what to expect. If your management team can answer all the due diligence questions thoroughly and clearly, doing so will avoid multiple follow-up questions. This type of preparation allows them the ability to continue focusing on their daily tasks.

Final Report and Negotiation

When the due diligence team concludes their visit to your facility, the expectation is that they will review all of the information provided in detail and communicate any additional inquiries. Then, they will complete their report and submit it to the buyer. It is up to the buyer to use the results as a negotiation 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 evident that being adequately prepared for the financial due diligence process is critical to the completion of a successful acquisition.

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

If the financial information is considered disorganized, not accounted for properly, or not supportable, the buyer could assume that the results provided may not be an accurate depiction of the business. The buyer could view 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. Our team can ensure your financial records are accurate and organized before the start of the due diligence process. Our experts can help prepare supporting schedules and documentation that may be requested by the due diligence team. We can gather and arrange a sell-side due diligence or quality of earnings report, so you’re fully prepared for the financial due diligence process.

Don’t go through the financial due diligence process underprepared or alone, contact us for more information or a free consultation.