Financial due diligence provides transparency and cost efficiency
As such, it is important to plan the individual stages of a transaction in such a manner that these objectives are achieved. Achieving transparency of the target at an early stage is commonly the most important aspect for both sides. Financial due diligence can provide exactly this transparency, and in doing so establish a foundation of trust between both parties to a contract.
The advantage of financial due diligence for the vendor is that risks may be identified at an early stage, giving the vendor the opportunity to actively address these risks and minimise them ahead of the transaction. It also decreases the risk of lump-sum purchase price reductions suggested by the buyer within the scope of due diligence proceedings, as the buyer is in a position to better evaluate these risks.
For the buyer, financial due diligence provides more detailed information to assess the opportunities and risks of the target that enable the buyer to come to a solid evaluation. This can represent a clear strategic advantage in the increasingly common bidding process, as it can exclude lump-sum reductions in value due to opaque risks.
Structuring financial due diligence
The typically successive phases of a planned transaction – starting with identifying a target through to integrating it into an existing group structure – require various examinations of differing scope for the planned transaction to be completed successfully, all while taking into consideration cost efficiency and the individual needs of the vendor/buyer.
At the start of an intended acquisition/sale process, it is advisable to receive an impression of the target, with minimum expenditure. This approach is best served by the preparation of a red flag due diligence report. By conducting a rough analysis of the information and documents available, the essential value drivers and risks can be identified. The findings of this analysis put the buyer/vendor in a position to make an informed decision already at this early stage of the transaction process on whether to proceed or not, without incurring substantial ancillary costs. Ideally, deal breakers are identified at this stage already.
If the decision is in favour of the transaction, the performed red flag financial due diligence provides the basis for the focus of the analysis in the further process.
Depending on the target, due diligence analyses conducted in preparation for an acquisition/sale decision address a number of individual issues from various areas. However, their objective should always be to assess the expected opportunities and risks for the cash flow. The income alone is not the measure of all things. The income is rather the path to the cash flow, and it is only cash that can be distributed to the shareholders ("Cash is a fact, profit is an opinion.", Alfred Rappaport, 1986).
A financial due diligence report presents the findings of the business analysis of the target, which forms the basis for the final decision to buy/to sell. It, however, also regularly contains recommendations for handling the risks identified (deductions from the purchase price, representations and warranties, etc.). At the same time, the report has another, quite different, positive effect that is not immediately obvious. The buyers have a document in their hands that facilitates access to borrowed capital due to the transparency of the data presented in it. This also helps in obtaining more favourable financing terms.