Preparing for a successful due diligence transaction

Due diligence is an important part of any transaction. The most common type of due diligence is Financial Due Diligence, and the tips below are intended to help you prepare for such a project, making the process as effective and efficient as possible.

Understanding the business

A Financial Due Diligence will generally involve obtaining an overview of the business operations including but not limited to:

• Establishing how the company has grown and evolved
• How management manage and monitor their roles and time
• Understanding the strategies and objective of the business
• Profiling the key members of management
• Gathering insights into the customer base including customer contracts, terms of trade, customer attrition and concentration
• Routes to market and different types of agreement with customers
• Understanding any fluctuations in revenue and a company’s revenue recognition policies
• Pricing strategies
• Cost profiles
• Staff costs and organisation structure
• Inventory management
• Accounting methods

You should be prepared to answer questions and provide evidence of this information through walkthroughs and supporting documents. By demonstrating confidence and robust responsiveness, you will gain credibility, giving the investor added comfort regarding the quality of the business.

Cash Flow

It is essential to understand how quickly profit turns to cash and the key components of cash generation. Cash is the lifeblood of a business.

Audited financial statements

Many small businesses carry out financial reporting solely for the purpose of filing the annual accounts and tax returns. While a financial audit may seem like a disproportionate and complicated exercise, it can raise the standard of the financial information, thus raising the investor’s confidence.

Cash versus accrual basis

Some businesses, especially some early stage fast growing technology businesses, may use a cash basis of accounting, whereby revenue is recognised when payments are received, and expenses are recorded when paid. Investors, however, want financial statements where revenue is recognised when earned and expenses accrued when obligations are incurred. The accruals basis of accounting gives the buyer a clearer picture of the earnings of the business. A good accountant will ensure that company’s financial reports present potential investors with a clear story.

Get organised

Financial Due Diligence information request lists can be comprehensive and thorough. Advisers performing due diligence will generally request three to four years’ worth of information organised monthly. Reports typically requested include:

• Statutory and monthly management accounts
• Integrated forecast models
• Customer sales data
• Aged debtor and creditor lists
• Inventory records
• Payroll records

Being prepared and responsive will help you to provide third parties with the information necessary to complete due diligence in a timely fashion. Plus, this will provide comfort for an investor. It will therefore help a company position itself for higher valuations, stronger negotiations, and better outcomes.

At DTE Corporate Finance, our Transaction Services team has a great deal of experience providing Financial Due Diligence to companies, banks, private equity houses and private equity backed corporates, as well as other funders for a range of transaction sizes and types.

Due diligence should be a key element in any acquisition or investment process. We work closely with our clients to develop an appropriate scope of investigation that meets their needs. We work hard at ensuring that the format is tailor made for the client and identifies all issues.

To learn more, please contact a member of our team on 0161 819 1910 or [email protected].