Growing a business through a merger or acquisition is an exciting time for everyone involved. One emotion no one wants to feel is surprise—especially as you move closer to signing on the dotted line.
Whether your M&A is part of a generational succession plan, a competitor buy-out, or something wildly different, one guiding truth is that no two mergers or acquisitions are ever the same. While applying a standard business review can be helpful, engaging independent advisors to complete a detailed financial due diligence process will better prepare you for a successful outcome.
Why the Majority of Mergers & Acquisitions Fail
Mergers and acquisitions are known to have a high probability of failure. You might question the wisdom of going down a path that faces those odds, but with M&A those who do succeed can win big.
There are three primary reasons that prospective mergers or acquisitions fall apart:
- Overpaying – When a buyer doesn’t have an accurate valuation or conduct an intense financial due diligence examination, the possibility of overpaying rises exponentially.
- Overestimating Cost Savings – Ultimately expecting to save on expenses and receive pricing discounts are often what lead to many M&A failures. The synergies that are expected to be gained don’t materialize or weren’t significant enough to justify merging the entities.
- Post Merger Integration Process – Combining the organization’s employees, cultures, IT systems, and product lines are challenging tasks that require substantial planning and delicate execution. Mis-aligned companies sometimes must be disentangled and have the attempted merger unwound.
If you have audited financial statements, why do you need financial due diligence?
When the target company has audited financial statements that are published or shared with the prospective buyer, some individuals wonder whether going through a financial due diligence process is even necessary. The short answer is a resounding YES.
Audited financial statements are useful to buyers but the information they provide is limited.
The following are differences between the two with explanations of how they vary:
- Purpose – Audited financial statements are often required of businesses by regulatory authorities, lenders, or investors. Financial due diligence is conducted during an M&A transaction to help buyers determine whether their offered price is reasonable, if an adjustment is needed, or to potentially withdraw their offer.
- Audience – Audited financial statements are prepared for external users while financial due diligence is prepared exclusively for the buyer and those with whom they wish to share the information.
- Scope – Regulations define the requirements of audited financial statements. Conducting due diligence has a broader scope and seeks to learn about the target company’s economic and non-economic financial risk factors, their historical trends, and the potential future gain to the buyer.
- Coverage Periods – During financial due diligence, monthly interim trial balance reports and data are analyzed. This allows trends and anomalies to be identified and reviewed. Annual audited statements are limited to a fixed date at the end of each fiscal year.
- Focus – Audited financial statements are records of transactions that occurred in the past, while financial due diligence aims to take the target’s detailed data, extrapolate observations, and create cash flow projections for the future.
Why Both Quantitative and Qualitative Data Matter
Completing a merger of entities or acquiring new locations isn’t solely about the numbers. The values on the balance sheets, inventory records, and compensation plan expenses certainly matter a great deal, but it is necessary to look beyond the numbers.
A key focus of financial due diligence is to identify areas of risk for the buyer. This includes assessing both economic and non-economic conditions. Identifying inherent risks of the business and industry, the market condition for its products, and competitor analysis are completed along with more traditional financial analysis. Other information can be obtained during formal interviews, casual conversations with employees, or within the footnotes of the financial statements.
Learning about the frequency of litigation activity, the health condition of a key senior manager, an acceleration of receivables collections, or delay in paying vendors can have a significant bearing on the price that the buyer is willing to pay for a target company. While the values within audited financial statements are likely accurate, identifying and reviewing judgement calls and business practices is vitally important to arriving at the correct valuation of a company.
Close In on the Right Call with Financial Due Diligence
Mergers and acquisitions are sophisticated, complex transactions that require a great deal of experience to be properly executed. While sellers may have the upper hand of knowledge at the start of a transaction, after financial due diligence is completed by independent, experienced professionals, buyers gain confidence and the information they need to achieve the results that are right for them.
REDW’s Valuation and Transaction Advisory team works diligently to provide comprehensive financial due diligence for our commercial, Tribal, and private equity clients. Reach out today to learn how our experts can help you grow your business through mergers and acquisitions. Contact us.