Every team member must do their part.
By Ed Mendlowitz
77 Ways to Wow!
In 2012, Hewlett-Packard announced an $8.8 billion deduction claiming that they overpaid for an acquisition because of the failure of many other people who were responsible for due diligence. I don’t know many of the details, but it seems that someone screwed up big-time.
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Due diligence is an essential activity in an acquisition that involves confirming the representations made by the seller, evaluating the strategic fit and terms and conditions of the deal and validating financial, legal, operational and technological aspects of the transaction. Keen due diligence can even help determine the final price.
A due diligence team is comprised of management representatives and transaction support advisors that can include a CPA firm, financial consultants, appraisers, insurance, risk and technology specialists, intellectual property experts, investment bankers and legal counsel.
Before the deal is penned, the team would assist in constructing the letter of intent (LOI) based on preliminary review of the data provided by the seller. The LOI addresses key terms for the transaction such as how the final price is determined, what assets are acquired, form of payment (cash, notes, stock and/or earn out), closing schedule, scope of due diligence and transaction drivers.
Following the LOI, the buyer proceeds with due diligence. As a first step the team familiarizes themselves with the company’s history, ownership structure, board minutes, major products, markets, financial statements, cash flow, loan agreements, tax records, contracts, leases, regulatory records and filings, labor contracts, employee listings with salaries, pension records, bonus plans, personnel policies, insurance policies, site evaluations, trademarks, software license agreements and joint venture and strategic alliance agreements. Depending upon the industry regulatory adherence, quality and quality control procedures will also be tested.
While many of the individual procedures are standard, the process needs to be customized for each transaction using flexibility to adjust the process based on available information, scope limitations and results of the findings.
Virtual data room, data mining and other technology tools enable much of the work to be performed offsite and facilitates workflow, testing and analysis and easier completion while maintaining security and secrecy of the process.
Occasionally the findings impact materially on the terms of the transaction. Some common findings are understated or hidden liabilities such as pension obligations, product warranties and lawsuit claims; low quality of assets such as inadequate allowances for bad debts and non-saleable or obsolete inventory; and reduced quality of the earnings such as where deferred sales are reported as current sales, or some costs are capitalized.
Due diligence is an essential and involved process that needs care; focus; keen investigative, auditing and observation skills; and a thorough understanding of the target’s processes and accounting reporting. Actually, the Hewlett-Packard news report claims and rationale for their write-downs provide the ABCs of what is required in the due diligence process.
