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Due Diligence: Sometimes Even The Best Miss….

February 10th, 2010

            One of the things that I love about what I do is the opportunity to continue learning, whether that’s during the course of my day:day activities, or through the actions of others….good or bad. One area I have a real interest in is that of acquisitions and the manner in which they structure and strike their deals. What’s even more interesting is how those same folks approach the due diligence process. For some, it’s about speed, trying to capture 90% of the key data, and hedging the other 10% in one form or another. For others, it’s about a slow and methodical approach, turning over every rock, and scrutizing every report, employee, past employee, vendor, and service provider. I’ve seen both approaches….and I’ve seen them both fail as well.

            In a recent dinner conversation with someone in my network, we were discussing a recent acquisition and the manner in which the due diligence was conducted. The entire due diligence process lasted all but a handful of weeks before the investors came rushing in. What was unfortunate about the situation is that the corporation had a real estate loan that was not reflected on the balance sheet, and the mortgage payment that was being made was reflected as a lease payment. A further unfortunate discovery was that the building was purchased only in the last handful of years when real estate was approaching a fully valued scenario and is now valued significantly less.

            Unfortunately, in the haste to conduct the due diligence, it appears the reviews went no farther than system generated financial statements, banking records, and reconciliations of vendor payables.  Yes, there was a review of stated assests, but only those reflected on the balance sheet. Although it was likely that there was not any ill intent in the actions of the incumbent owner, it was an unfortunate discovery. The omission on the balance sheet was, in further review, likely attributed to the fact the during the 10+ history of the company, there was never a CFO or other key financial figure. Keep in mind that the investor group leading this effort were seasoned professionals and had generated significant wealth in their execution of prior transactions.

            So how do you avoid such a predicament in your own future transactions? It goes without saying that the itemization below is not an exhaustive view of approaching an acquisition, but merely a start to analyzing every element of the situation…

·         Who are you really dealing with…have you conducted background checks on key stakehoulders?

·         Have you run a full credit review / D&B on the corporation to identify all loans, liens, and other considerations?

·         Are there reconciliations available for all material balance sheet items? Reviewed?

·         Has the existence of all material assets on the balance sheet been confirmed?

·         Have a review of banking statements, vendor purchases, A/P balances, and A/R balances confirmed figures reflected within the income statement?

·         Have all tax returns been submitted on time & correspond to the income statement?

·         Are there contingencies built into the agreement to hedge against any unforeseen risks, unknown off-balance sheet liabilities, or any other non-reported liens?

            Like I said, this isn’t even close to an exhaustive list, which should ultimately be an extensive punch list of data to review, forecasts to be developed and riddled with considerations, and ultimately, considerations given to the respective cultures and other intangibles. Truly a complex jigsaw puzzle to consider….

 

Thanks for reading . . . .

 

Jeffrey Ishmael

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