This article was written by TJT senior manager Diane J. Dennis, CPA and originally appeared in the AICPA’s CGMA Magazine.
Most CEOs and CFOs do not have such a high level of trust across the table that they can close a deal after a brief conversation and a handshake. Instead, they engage in buy-side due diligence, scrutinizing every number and negotiating hard for the best sale price. In some cases, companies can spend great amounts of time and money but never complete the deal.
Three areas that receive the most scrutiny during this process are quality of earnings, tax exposure, and IT integration. Cultural fit of the organizations, while sometimes overlooked, is the fourth area that can lead to acquisition derailment. The best move around these potential roadblocks is sell-side due diligence, for which benefits far outweigh up-front costs.
Quality of earnings. Typically, buy-side due diligence involves tearing apart the balance sheet and profit and loss statements and normalizing EBITDA for what buyers think it may look like when they take over operations. They will identify atypical accounting policies, missing accruals, one-off transactions, and tax impacts. By closely examining business operations, they will identify pro forma adjustments to EBITDA affecting deal value. Any surprises uncovered during due diligence will leave a buyer feeling uncertain about whether there are other undiscovered issues. This will impact the purchase price as the buyer seeks to mitigate its risk.
Tax exposure and deal structure. Taxes can be a roadblock for both sides in a deal. For the purchaser, the problem is potential unknown tax liabilities. For the seller, it is how to structure the deal to minimize tax impacts to shareholders.
Potential liabilities may exist for the purchaser from federal and state returns, payroll tax liabilities, sales and use, franchise tax, and multistate jurisdictions for tax years preceding the deal that are still open under the statute of limitation. But the biggest tax risk is unknown liabilities that could arise after the sale is complete.
For the seller and its shareholders, it is imperative to look at the tax implications of the deal structure. There are many options and nuances to consider in determining whether an asset or stock sale is most appropriate and what the tax consequences will be.
IT integration. Information technology is vital for business operations. Given its complexities, IT should not be an afterthought during the deal process. While companies are often focused on the financial aspects of an acquisition, IT can make or break a successful integration that creates value.
Today, companies use a wide array of platforms, often with customized coding linking the systems internally and externally. At the very least, compatibility, security, integration, and the level of documentation available need to be considered. Given the intricacies, IT warrants specific review by an IT due diligence professional to determine potential risks and integration issues. Working with the acquirer, both parties should focus on a plan to ensure a smooth implementation well before the deal is done.
Cultural fit. Critical to extracting value from the deal and successfully integrating the acquisition is how well the organisational cultures meld. Do the organisations and management have the same values? How are customers and employees viewed and treated? Do they have similar employee policies? Regardless of the answers to these questions, if management struggles to gain the trust of new employees and integrate the cultures of two companies, deal value will be lost on turnover, employee relations, and the hiring process.
Sell-side due diligence. Taking time to prepare your company for sale will provide several benefits, including smoothing the sale process and improving buyer trust. Engaging an accounting firm to provide sell-side due diligence will be worth the investment and should easily be recouped.
Sell-side due diligence entails an in-depth examination into your financial and business operations. An advisory firm will examine your financials and quality of earnings. Advisers will anticipate potential buyer concerns and identify potential issues to address. Advisers also can look at IT, human resources, tax, and legal areas. Once the firm has completed its work, it will provide a report that can be shown to potential buyers. The report can also include your data room (for physical and electronic document storage) and financial information for buyer review.
Preparing information in advance creates trust, credibility, and leverage with the buyer when negotiating a deal. It allows a company to have a more competitive bid process and smoother and quicker due diligence by a buyer, keeping the deal on schedule. It also improves the probability that the deal closes successfully.