Due Diligence: Staying ahead of the game

You wouldn’t buy a car without having your trusted mechanic look under the hood, right? That same idea should be applied when buying a company without having your trusted financial advisor perform due diligence.

Whether you’re buying a car or a company, it can be easy to get emotional about the purchase or deal. But keeping your head in the game and moving forward with all of the necessary diligence items helps ensure there is a successful outcome and that you are aware of any obstacles, risk or expenditures post-acquisition.

Most buyers understand and know the importance of due diligence, but it’s easy to backslide and rely on a few financial markers that may or may not indicate a good deal. Here’s a reminder of some due diligence steps to take to help you dig deeper and ensure you’re on the right track.

Start early with a clear focus

Before you open a  financial statement, consider documenting the risks in the industry, geography, labor concerns and other applicable economic conditions, as well as key metrics.

This risk assessment helps identify what’s most relevant and where your greatest exposure lies, as well as what trends you might expect in the financials. Risk assessments save time because you’re targeting due diligence on what matters most.

Evaluate reliability

Now tackle the financial statements, keeping in mind your risk assessment. First, evaluate the reliability of financial information. If it’s prepared by an in-house bookkeeper or accountant, consider the skill level and whether the statements conform to Generally Accepted Accounting Principles. If statements are prepared by a CPA, consider the level of assurance: compilation, review or audit.

• A compilation is generally a CPA taking what the business owner gives them and compiling them in a file and printing on their letterhead.
• A review includes analytical procedures where the CPA is required to look at prior year numbers and current year numbers and inquire on the fluctuations. There are no requirements for detail transaction testing in a review.
• An audit is the highest level of assurance that a CPA can provide. It is required for the CPA to perform transaction-level testing where invoices and other source documents are reviewed.

Once your advisor determines the reliability of the financial statements, the required scope for proper due diligence can be customized.

Further, as risk and exposure areas are identified by your advisor, ask yourself whether these items, in conjunction with your preliminary risk assessment, still hold for a good deal. Brainstorm possible solutions to address these risk and exposure areas and make sure you have the right team in place to properly execute.

Don’t get emotional

Every deal carries a certain amount of uncertainty and risk. Keep a scorecard for any red flags that are raised throughout the due diligence process. But, to minimize the potential for problems down the line, that uncertainty needs to be quantified, documented and analyzed. Don’t get emotional about the deal. Taking these due diligence steps can help make you more comfortable on the day you’re making that wire transfer.

Thinking about acquiring a company? We can help you with the proper due diligence so you can make smart M&A decisions.