Financial and tax due diligence
Due diligence is a review agreed in advance between the buyer and the seller focused on accounting, tax, economic, technical or other aspects of the company.
Due diligence involves a pre-agreed review between the buyer and the seller, encompassing various aspects of a company that a client intends to purchase, sell, finance, or control. This includes accounting, tax, economic, technical, or other areas. Financial due diligence focuses on scrutinising individual items in the target company’s financial statements to identify risks resulting from incorrect accounting or misstatements, such as overvalued assets or undervalued or undisclosed liabilities. Tax due diligence, on the other hand, centres on tax-related risks, including tax compliance and the correct application of tax laws.
The scope of due diligence is flexible, depending on the client’s needs. It can range from a basic review of key aspects to a comprehensive examination. The materiality threshold, which may vary across different risk areas, is established beforehand based on pre-agreed conditions.
Due diligence application
Primarily used in investment planning for business or asset acquisitions, due diligence is a crucial step for investors before executing a transaction. It can also be initiated by the seller. The findings from due diligence typically inform negotiations on the purchase price, aiming to prevent potential losses for the involved companies and to account for identified risks in the proposed purchase price. Additionally, due diligence is instrumental in securing financing (as required by the financing partner) and serves an audit function, such as when government bodies audit the management of state-funded organisations.
Potential risks if due diligence is not exercised
Neglecting due diligence can lead to unmet expectations from a transaction, such as when a target company fails to generate anticipated profits due to misrepresented results or increased costs from penalties for non-compliance. Thus, understanding potential risks is vital for informed decision-making.
Due diligence process
The advisor’s role primarily involves examining documents available in the data room, typically a virtual space providing authorised online access for document management and storage. Due to the sensitive nature of the information involved in a transaction, communication is generally restricted to a limited group of individuals. The advisor directs queries to a designated contact person, and the client is kept informed about the due diligence progress at regular intervals. This approach allows the client to engage in the review process and request further examination of specific areas as needed.
Due diligence report
The outcomes of the due diligence process are detailed in a comprehensive report that discusses each focus area and highlights potential issues. This report is valuable for negotiating the purchase price or securing financing.