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Financial due diligence, and a pig in a poke

Since childhood, we have been told that buying a pig in a poke is not a good idea. In transactions involving the acquisition of a business – that is quite a lot of money – the pig and the poke are first carefully examined and only then bought.

Financial due diligence is a review agreed in advance between the buyer and the seller and focuses on the accounting and financial aspects of the business that the client is considering acquiring. A financial due diligence exercise usually identifies risks (even in audited companies) that can either be dealt with before the transaction is conducted or a choice is made between a discount on the purchase price and the seller providing the buyer with warranties. Due diligence can of course be initiated by the seller and the findings are presented to potential buyers. In some cases, the planned transaction is only known to the top management of both the buyer and the seller. This is fully respected by the adviser who primarily focuses on documents available in the data room (usually virtual) and who directs questions solely to the designated contact person. The client is informed about the due diligence process on a regular basis (e.g. once a week). Consequently, the client can become involved in the review and, where necessary, have certain aspects examined in more detail.

The most important due diligence findings include:

  • Failure to report a (contingent) liability (such as arising from a dispute)
  • Bad debts of a significant value
  • Failure to discharge statutory duties
  • Target company dependent on one or (a few) customers
  • Slow-moving inventory, and so on.

In practice, financial due diligence is often combined with tax, legal and sometimes technical due diligence. When several due diligence exercises focused on these areas are conducted at the same time, the teams usually work closely together as their findings have an impact on multiple issues (e.g. from a financial perspective, liabilities overdue for a long time may have an adverse impact on the cash flow from assessed interest, and from a tax perspective, an obligation may arise to pay additional tax on the liabilities). This allows the client to obtain key information for the right decisions during the transaction.

Due diligence findings are summarised in a report that can be used for negotiations for the purchase price or for obtaining funds for the contemplated transaction. The scope of the due diligence is optional (depending on the areas and periods of inquiry). Only basic areas can be examined that are of interest to the client, or an in-depth, extensive analysis can be conducted, depending on client specific requirements.

RSM CZ is also a provider of comprehensive M&A consultancy including due diligence. We offer tax and financial due diligence services to Czech as well as foreign clients.

 

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