A due diligence audit has an important role in the success of a transaction. It is not simply another added cost in the transaction process; rather, it is an investment made by the buyer in order to ascertain what exactly they are about to buy. A due diligence audit may uncover circumstances that have a significant impact on the end result of a transaction, especially if it is discovered during the process that the investment product which seemed like a great opportunity is actually not as rosy as it first looked. Below, I shall highlight some signs of risks that the seller may have carefully hidden, but which may give the buyer some food for thought.
As a buyer, it is first worth ascertaining and specifically agreeing with the seller on what they wish to sell and what the scope of the proposed transaction will actually be. Could the seller be interested in selling a company as a whole? Could the seller be interested in selling part of a company or business activity as a facility? On the sale of a company, for example, is the object of the transaction actually the whole company or is the seller interested in leaving some assets out of the transaction? If the transaction does not involve the company as a whole, it is worth considering what acquiring a company partly without assets would mean in reality.
The above questions must always be cleared in the negotiation stage, so that no unexpected aspects are discovered later on in the due diligence audit stage and that the concerned parties have the same understanding of the scope of the transaction. Thus, it is worth spending more rather than less time on negotiating and agreeing the scope and conditions of the transaction in the negotiation stage.
Although preliminary conclusions about the financial results and standing of a company can be drawn on the basis of financial data, interviewing the management in the course of the due diligence audit may reveal significant information about what is behind the figures. This may be particularly so in cases where answers to questions are vague and the management of the company is reluctant and laconic in providing information. In some cases, this may indicate that the background of the transaction is something other than what has been thus far presented to the buyer. It is worth being prudent when the seller is not willing to share certain important information.
If it is known that the company has been recently restructured or divided, it is reasonable to investigate the reasons behind such processes. Attempts are often made to hide messy financial reporting, to gain from the sale of a company that is substantively empty, to create a more advantageous situation for a business in line with the legal acts regulating the specific area, etc. Hiding important facts may ultimately bring more loss than gain to the seller, as it is possible to ascertain in the course of a due diligence audit whether the divided companies are able to continue as separate units in reality. If such signs of risks are only discovered after negotiations, the buyer may decide to withdraw from the transaction. Therefore, better safe than sorry.
An external observer may not necessarily see at first that the company’s business activities include many shortcomings, particularly in business processes. Depending on the management culture and previous management decisions, the seller may have postponed the necessary development and replacement investments. For instance, the company may be using obsolete technologies or outdated software solutions. In the case of a capital-intensive business, the buyer needs to understand the existing core assets base and the items that need updating. If these are important for achieving strategic objectives, the buyer must bear considerable expenses after the transaction.
Although at first the acquisition of a company that has caught your eye may seem like a good idea, it is always worth considering the activities after the transaction. This is particularly so in the case of strategic investors – how well do the strategy and the business activity of the acquired company match our business activities? If the business model or a part of the business model of the company of interest differs from the buyer’s business model, it is worth considering to what extent the two businesses can be mutually integrated without an additional headache or unreasonable expenses. Thought should also be given to the synergy to be created after the transaction and to whether the synergy will materialise.
The seller’s unreasonably high price expectation may also be one reason why the parties proceed no further than the negotiations stage. The seller’s inflexibility in pricing may not leave room for the parties to bargain and compromise. No buyer is willing to overpay if the yield on the investment does not meet their minimal expectations. The more thoroughly the parties agree on the price formula and the more precisely the components of the price formula are defined, the more transparent the negotiations can be. It is important for the seller that business activities also continue in subsequent periods and function without major setbacks.
At the same time, if the buyer is proposing too low a price, the seller should in turn contemplate whether the transaction is sensible. Although on the grand scale it is reasonable to look at the prices of similar transactions in the market for comparison, it is always worth taking note of company-specific factors and, if necessary, adjusting the price in order to arrive at a reasonable price.
The later any doubts about a transaction arise, the more costly the entire process will be for the buyer. In the event of a failed transaction, it is those things that could have been prevented through clear, transparent communication and timely, preliminary work that cause the most frustration.
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