The Innovator’s Counsel: Financial Due Diligence – Let’s Buy a Company!

Jeremy Weltman Uncategorized

The primary objective of financial due diligence is to develop a comprehensive and focused review to assist a potential buyer in the uation of a target business (“Target), usually in connection with a transaction.

When you’re considering buying a company, or some part of it, the performance of proper financial due diligence on the Target is of utmost importance so that a Buyer fully appreciates and understands the “ins and outs” of a Target’s finances – particularly the extent and scope of liabilities, collectable accounts receivable and fixed assets.

The “dollars and cents” of the transaction will also influence the majority of major deal parameters such as pricing, financing (if applicable) and structuring of the acquisition. Quantification of the “dollars and cents” is largely based on a particular Target’s financial information, so properly understanding and assessing the reliability of that financial information is a critical step in uating a transaction, and represents one of the primary reasons for performing financial due diligence.

Of course, each deal will have a unique set of economics and the whole collection of reasons for performing – and the extent so performed – financial due diligence will vary from deal to deal. That being said, in practice, the majority of financial due diligence activities will likely include one or more of the following objectives:

  1. Checking the Target’s Reported Financial Information

Depending on the relative size and complexity of a given transaction, it may be necessary and advisable to request the Target provide more detailed financial information than its self-generated Balance / Profit & Loss Statements provide. In doing so, a potential Buyer may be able to verify (to the extent possible) that the financial information Target is providing is a proper representation of the Target’s bottom line. One way to do this is to ask the Target to engage an attorney as an advisor so that financial information provided by the Target through their attorney can, at the very least, be reconciled back to Target’s audited or externally reported financial statements (to the extent such professionals are held to standardized ethical standards governing their practice, thereby dis-incentivizing an attorney from providing clearly fraudulent information for  due diligence consideration by a potential Buyer).

  1. Identifying and Performing Independent Due Diligence of Potential Financing Sources

If the transaction is a leveraged acquisition, the Buyer will frequently require support of its debt providers. This support may be conditional on performance of independent due diligence procedures.

  1. Thinking About Target’s Business Model

A Buyer may perform due diligence to obtain an independent opinion of the risks and unique considerations associated with Target’s particular business model in Target’s particular industry.

  1. Looking for “Other” Risks, Potential Exposures and Liabilities/Commitments

Target’s reported financial information will almost never encompass all financial commitments, potential exposures and liabilities of a Target. Proper financial due diligence, performed with the assistance of an attorney familiar with best practice procedures designed to identify these “other” risks, allows a Buyer to properly consider such “other” risks when engaging in negotiations and entering into agreements related thereto.

  1. Target Performing Self Due Diligence

Often termed “sell side” due diligence, those looking to sell their business may engage professional advisors to perform due diligence on the entity or property that is potentially for sale. As with everything, the reasons for performing this type of due diligence will vary, but often “sell side” due diligence provides invaluable information to assist a potential Target in developing a sound negotiation position or identifying potential problems before they become deal breaker.

No two transactions are the same, which is why it is important to formulate and engage in a proper financial due diligence plan when seriously considering an acquisition. No matter the relative scope of the transaction, the cost of hiring an attorney to guide and protect you through the process will be returned in spades by ensuring to the extent possible that what you’re buying is worth what you’re paying.