Due diligence is always an important component of a successful acquisition. As operations become increasingly complex and financial statements more opaque, the need for rigorous due diligence has never been more important.
Challenges and Opportunities
The difficulty in properly vetting a target lies in analyzing an abundant amount of financial and operational information within a relatively short window of time. This not only obscures a buyer’s ability to identify the target’s key value drivers, but also strains qualified resources that are available. The advantage, then, goes to buyers who can execute efficiently and effectively – leveraging existing industry knowledge with an ability to distill the key information that is most important to the decisionmaking process.
Our Point of View
The most effective diligence process is accomplished through a comprehensive analysis of the target’s financial performance – centered on the following three distinct areas:
Quality of earnings – Organizations must determine whether the current financials are an accurate representation of the target’s true earnings power by assessing estimates and highlighting nonrecurring or unusual income and expense items. Items that should be considered include:
- How closely do the target’s earnings approximate cash flows and how are variances explained?
- What is the fundamental driver of earnings and which historical items should be excluded from assessing earnings quality?
- How realistic are the target’s projections in light of historical results and its operating environment?
- What is the required capitalization of the entity and what are the future capitalization requirements?
- What accounting treatments does the target utilize in relation to its peers and what is the reasonableness of estimates?
- Is the target subject to any off-balance sheet or contingent liabilities that were not disclosed by management?
Financial and operational trends – Organizations should identify and analyze key financial and operational trends that are important to gauge the likely future earnings power of the target. Generally, this includes:
- What are the key factors that are driving margin compression or expansion, rate of cash conversion and return on invested capital?
- What is the impact of business landscape or regulatory change on the target’s earnings potential?
- What is the target’s performance with respect to key performance indicators and what are the quality and reasonableness of the benchmarks established?
Tax diligence – Taxes can present additional opportunities and risks to the buyer. Companies must understand these risks and opportunities by gaining insight into the optimal structure of the transaction to utilize tax attributes. They also must ensure the target has incorporated all future tax liabilities into its projections. Key questions to ask include:
- What are the tax implications of completing the transaction?
- What is the optimal structure to maximize tax attributes in addition to meeting the needs of the buyer?
- What are the ongoing tax liabilities of the target and what is the impact on the deal’s internal rate of return?
A well-rounded approach to financial due diligence requires proper planning and the right expertise during execution. By focusing on the quality of earnings, financial and operational trends, and tax implications, buyers can obtain a comprehensive picture of the target’s financial risks and opportunities.
How We Help Companies Succeed
Merging two or more organizations is a complex transaction filled with risk. The best deals follow a structured and disciplined approach with clear strategic objectives, comprehensive due diligence, detailed integration plans, and a focus on creating and capturing value. Although such planned approaches may sound simple, history shows many failed M&A attempts that have resulted in significant reductions to shareholder value.
Our structure allows us to respond quickly to your needs on a global basis with cross-disciplined teams that bring broad perspectives and deep expertise and are capable of leading the transaction and work streams while evaluating a variety of business and regulatory issues. With our structure, we are uniquely able to deploy a flexible delivery model that adapts to the constantly changing fixed and variable resourcing needs of each transaction.
We have assisted some of the world’s largest organizations with some of the biggest transactions in history, providing services across a range of operations and industries. We focus on key risk areas utilizing our proven project management tools and techniques to provide you with clarity on financial, accounting and tax components of the transaction.
Medicaid/Medicare Health Plan
We advised a large hospital chain system and national health insurer in their potential acquisition of a 50,000-member Medicaid/Medicare health plan. As part of this work we: (i) analyzed the health plan’s quality of earnings and assets, (ii) assessed profitability trends, and (iii) interviewed management regarding operational risks and opportunities. Our due diligence findings identified business risks and areas of concern regarding the future profitability of the health plan and provided a basis for our clients to analyze the deal’s economics appropriately. This enabled our clients to make more informed decisions regarding the value of the health plan and, as a result, our clients commenced renegotiations with the seller.
Professional Sports Team
We advised a minority owner of a professional sports team in the acquisition of remaining controlling interests. We assisted our client in raising millions in equity capital and obtaining debt refinancing. As part of this work, we assisted management in: (i) developing marketing materials, including investor and lender presentations, for distribution to potential capital providers, (ii) preparing an integrated financial statement projection model detailing the entities’ potential operating performance and key assumptions, and (iii) negotiating the financial covenants of the credit agreement. Thanks in part to our efforts, our client was able to secure the necessary capital to close the transaction successfully.