Tips for a thorough due diligence process when acquiring or selling a business
When acquiring or divesting a business, being thoroughly prepared for the due diligence process can significantly simplify the divestment or divert risk and ensure future success for acquirers. To ensure this, below are a few of the multitude of areas that need to be investigated and warning signs that should sound some alarm bells.
It is important to look into the past financials of a company over at least 3 years, whilst investigating and understanding the causes of any significant changes in revenues or expenses. In undertaking this process its also necessary to ascertain when significant capital expenditure is required, and the intricacies of the business such as changes on profit margin trends and actions that have previously been positive and detrimental for the business, thus enabling the greatest level of success upon acquisition.
It is import to delve into the adjusted EDITDA , most recent financial accounts and customer lists. EBITDA can be subjective, thus if once you’ve investigated the add-back schedule you have a significantly different profit, it should raise concerns about the legitimacy of the deal. If the sale process is ongoing for some time and a business is reluctant to release updated financials, it may indicate that the business performance is in decline.
Understand the company’s expenditure on marketing, their placement in the market and the strategies that have been implemented to achieve this position. If you are a strategic buyer, synergies can be maximized by assimilating marketing strategies or keeping them differentiated, but it is still crucial to understand your target’s position in order to maximise the benefits of the acquisition or merger.
The major concern is if the company has reduced their marketing team or expenditure on marketing leading up to the divestment. This will lead to problems with acquiring customers and even maintaining existing customers post acquisition, and also signals a lack of intent from the current owner to assist once ownership has been transferred. Risks such as this can be minimised through having compensation strategies for the current owner post acquisition.
When investigating this aspect, discover how many customers the company has, and the percentage of sales concentrated on each customer. It is important to try and understand each customer’s motivation, their goals and how the business you are acquiring can assist in achieving these into the future.
If a business has a low number of customers or a high concentration of revenues come from one or two customers this should create significant concern and as a buyer you should be offering a lower profit multiple. You should also be concerned if a new customer has generated a significant portion of revenue for only a year or two. If the owner is now divesting, they may be uncertain of maintaining this customer into the future.
Beyond the organisational chart it is necessary to look at bonus schemes and compensation strategies such as leave, the use of cars, and any similar strategies the owner may be implementing to ensure staff morale is maintained. Of significant importance is also understanding management’s views on how the business could be improved and how they envisage their careers progressing in the future. An entrepreneurial owner may wish to take their best managers to their next venture.
High staff turnover and a history of resistance or lack of experience from management in implementing change can create a number of issues for acquirers taking over a business. On top of this records should be kept of previous staff disputes. Disputes are common in the work place and if the owners are withholding this information when asked, it should create some concern.