By Paul Henry, MBA | Financial Analyst
Doing Your Due Diligence
The term “due diligence,” at its most basic, means the level of diligence, or care, that is due, or appropriate, to the situation at hand. It means different things to different people, and it can mean different things in different transactions. While the specific procedures followed in a due diligence engagement can vary widely, the goal of the due diligence project is typically to help the client do the appropriate level of homework and to think things through before engaging in a transaction.
It is an unfortunate truth that in any transaction, the seller is more informed about the property being transferred than the buyer. This asymmetry of information is magnified in the customary deal process, which involves the buyer making an initial offer and signing a letter of intent based on limited information concerning the target. That offer is made subject to successful completion of the buyer’s due diligence, which typically means that there is a period of time during which the buyer can verify that a more detailed analysis of the target does not reveal significant defects in the target.
Questions to Consider
Another unfortunate truth is that information costs money. Therefore, it is impossible for the buyer to ever know everything about the subject company. It is therefore important that the buyer structure the due diligence process such that key questions are answered. Question areas might include the following issues:
- Operational - Can I continue to operate the business in the way that the seller is operating it, or will I have to make a significant change in the way the business operates?
- Legal - Can I assume the seller’s favorable long-term contracts, or will I lose these contracts when I buy the business?
- Accounting - Is there really $152 thousand in the bank?
- Other topics - Is an economic recovery likely to increase occupancy rates?
The only thing all due diligence projects have in common is that each is unique. We work with our due diligence clients to set up an appropriate scope of work in the context of the budget for the engagement, and we discuss with our clients the offer and the key assumptions underlying the offer in order to determine the appropriate areas on which to focus our due diligence. Ultimately, it is up to the client to determine the appropriate scope of work, and it is up to the client to determine the appropriate points of focus for our investigations. Typical components of a due diligence investigation might include:
- To assist the buyer in verifying the financial information supplied by the target;
- To help the buyer understand the value drivers for the target business;
- To verify that the key assumptions implicit in the buyer’s initial offer are reasonably correct;
- To help the buyer identify previously undisclosed risks;
- To gather information relevant to negotiation, valuing assets, and understanding the daily operations of the target business; and
- To explore specific areas of uncertainty regarding the target identified by the client.
Although it is impossible for a purchaser to learn everything about a target business, the due diligence process gives the purchaser an opportunity to look under the hood of the target business and to consider details not available during the initial analysis of the business. In the end, the onus is on the purchaser to ensure that a target business is what it appears to be, but our experienced professionals can help the buyer verify key information supporting that decision.
We Can Help
Decosimo professionals have performed many due diligence engagements and have assisted clients in determining the best course of action. If you have questions regarding a transaction or due diligence matter, please call us in confidence at 800.782.8382.
Brent McDade | Managing Director
Cole Powell | Principal