Scrupulous Due Diligence Bolsters the Buyer’s Advantage

As seen in Crain’s Cleveland Business

Issued the week of January 18, 2016

The current M&A market remains a “seller’s market,” both in terms of economics (purchase price multiples), as well as the structure of key deal terms.

The buyer may be at a disadvantage since there could be multiple potential buyers performing due diligence with no exclusivity nor any guarantee or commitment that they will be able to close the deal.

The confluence of all these factors makes performing thorough due diligence more vital than ever to best position the buyer to maximize her return on investment.

Among those best practices are:

• Understand key value enhancement drivers. What is the historical growth rate, and is it sustainable? What is driving such growth? Where are the opportunities to enhance revenue/profitability, and what actionable initiatives can be undertaken to achieve growth?
• Analyze quality of earnings to better understand the sustainability of historical revenue and cash flows. This includes assessing the impact of non-recurring, owner discretionary, and out-of-period adjustments on cash flows. It also includes assessing customer and vendor trends, as well as trends for the nature of cost of goods sold. Further, what is the history of sales price increases/decreases and vendor price increases/decreases?
• Assess the cash conversion cycle, and analyze the net working capital trends. How much capital is tied up in net working capital, and what additional working capital will be necessary to fund growth? Are there opportunities to reduce working capital and improve the cash conversion cycle?
• How realistic are pro forma projections in relation to historical performance? Are such projections built on a bottom-up or a top-down basis? It is critical to understand the underlying assumptions and to reconcile them to historical trends as well as the sales pipeline and order book.
• Assess the strengths and weaknesses of the infrastructure in place, and determine whether it is adequate to serve as a platform for growth. This includes the key management team, current workforce and the underlying systems that provide the data to monitor performance.
• Assess qualitative factors, including culture, attitude, mode of communications, teamwork, etc.

The above items represent a few of the factors to consider in terms of due diligence. It is critical to understand these topics when developing a business plan, including a 90-day plan on which initiatives will be undertaken post-acquisition.