Acquiring or investing in a business is no snap decision. Lisa Entwistle-Evans outlines some of the key areas to consider before you sign on the dotted line .
Think of buying into a business as you would investing in property. You wouldn’t exchange without having engaged a
surveyor to check it’s good standing and point out any cracks in the mortar. Likewise, you shouldn’t take a business
valuation as read without having had an impartial expert check on the firmness of its foundations. So if you want to ensure your investment is as safe as houses, then it’s time to sharpen your pencil.
“Due diligence” is a term used for a number of concepts involving an investigation of a business or person prior to signing a contract. The term was coined in the 1930s as a result of the United States’ Securities Act which referred to the “Due Diligence” defence. In other words, as long as broker-dealers exercised due care in their investigation into the company whose equity they were selling, and disclosed to potential investors what they found, they would not be held liable for non-disclosure of information. Nowadays, the term is used more loosely as the examination of a potential target for merger, acquisition, privatisation or similar corporate finance transaction (normally by the buyer, although sellers may undertake the same, for example if they have concerns over the buyer’s ability to fund the deal or successfully manage the venture post transaction).
Due diligence (DD) typically has two principal facets – financial and commercial; the former looks at the company’s financial and taxation position, taking into account past and projected performance, and in essence underpins the valuation of the venture; commercial due diligence however determines how a target’s position and performance
compares to both its key competitors and to the overall market opportunity, providing a holistic evaluation of
assumptions made in the financial projections.
Commercial and financial due diligence cannot be undertaken independently of one other; imagine a target company
claims that sales have grown 20%; financial due diligence subsequently reveals that figure is actually more like 15%, which is still strong performance, you may think; however, commercial due diligence indicates that the overall market
is expanding at a rate of 30% and in fact, the main competitor is actually growing 35% year on year. Well, that puts an
entirely different perspective on things. Commercial DD is much broader in scope than financial DD, analysing not just at the company itself but the wider macro environment. The size of the task is usually commensurate with the transaction value, but areas of focus should typically include:
– internal analysis, including products and services, reliability of supplier base, customers & strategic relationships, marketing strategy, salesforce effectiveness, distribution channels plus organisational issues including management strength and retention of key personnel;
– external analysis, spanning the overall market opportunity, market positioning/share and the overall competitive landscape plus careful identification and interpretation of any social, legal, economic, political and technological and environmental issues influencing the sector;
Not an inconsequential list, by any means, but then investing your cash and your future is no trivial decision either. And no two organisations are the same, which means there is no magic checklist to help you tick the boxes and whip out your cheque book (or run for the hills, as results may indicate).
For bespoke Corporate Finance transaction services, contact Lisa at CF@icaccountancy.co.uk