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Due Diligence


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Financial due diligence for acquisitions

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Due Diligence

  1. 1. ACQUISITION DUE DILIGENCE A Presentation forInternational Business Brokers Association June 6 and 7, 2003 Corporate Financial Solutions, LLC 1
  2. 2. Debra Pauli Corporate Financial Solutions, LLC Consultant, business troubleshooter and adviser CPA Completed testing portion for CTP, Certified Turnaround Professional designation Former CFO Former Controller of Multinational NYSE Company Conducted due diligence domestically and internationally Assessed businesses for lenders 404-237-5716 Corporate Financial Solutions, LLC 2
  3. 3. Disclaimer The information contained in this presentation is only intended for general purposes. It is not intended nor should it be construed as either legal, accounting or business advice. The material may not be applicable for specific needs or circumstances and is not a substitute for consultation with qualified professionals. All rights reserved. No part of this work covered by the copyrights herein may be reproduced or copied in any form or by any means without the express permission of the presenter and Corporate Financial Solutions, LLC. Corporate Financial Solutions, LLC 3
  4. 4. Acquisition Due Diligence Course Description Identify the Core Business’s  Obstacles  Opportunities To Prepare the seller for due diligence How can this information be utilized to maximize value for the seller A brief look at the unique problems of international acquisitions and international issues in domestic acquisitions Corporate Financial Solutions, LLC 4
  5. 5. Business Purchase or Sale The Merger & Acquisition process begins when a seller considers offering the business for sale or a buyer begins a search for a business to acquire. These early activities often lead to a business broker, investment banker, or other party bringing a potential buyer and seller together. As events proceed, the parties will encounter the due diligence process. Corporate Financial Solutions, LLC 5
  6. 6. Exactly what is due diligence?Due diligence is the process of conducting an investigation to determine the full implications of the proposed transaction. In this case, the purchase or sale of a business.Due Diligence is about information/facts Corporate Financial Solutions, LLC 6
  7. 7. The four key elements involved inthe purchase or sale of a business after the business is identified are: Due diligence and Valuation Tax Considerations of the transaction Capital structure before and after sale Negotiation, terms and conditions & Close Corporate Financial Solutions, LLC 7
  8. 8. Who benefits from due diligence? All parties to the transaction benefit  The buyer  The seller  Other Stakeholders (brokers, bankers, employees, customers, vendors, attorneys, accountants) How do they benefit?  The odds of a successful post-sale outcome are significantly higher. Corporate Financial Solutions, LLC 8
  9. 9. How does the buyer benefit? Buyer learns what he’s getting into. Buyer should experience few surprises with adequate due diligence. Buyer prepares to run the business. Corporate Financial Solutions, LLC 9
  10. 10. How does the seller benefit? By better preparing the buyer, it increases the likelihood that the seller will collect the agreed upon purchase price. Reduces possibility for post sale disagreements leading to possible litigation. Tax consequences of the sale for the seller are understood. Corporate Financial Solutions, LLC 10
  11. 11. Other Stakeholders – how do they benefit? Informed employees, lenders, vendors, customers Other stakeholders are part of the process and therefore have a stake in the future success. Knowledgeable buyers and sellers have realistic expectations Satisfied buyers and sellers means less turmoil for other stakeholders Corporate Financial Solutions, LLC 11
  12. 12. Information important to the buyer  the operations of the business  its key personnel and the risk of losing them  the tax implications of the acquisition  the legal, tax and contractual aspects of the business  technology issues within the business  environmental, regulatory and industry specific issues  nature and value of intangibles Corporate Financial Solutions, LLC 12
  13. 13. Additional information the buyer needs  The result of the previous activities are summarized in the financial information of the business  The buyer needs, specifically, to identify:  what will be bought – identify the core business  what is the cost structure  what are the revenue sources  what are the potential risks  what are the potential opportunities Corporate Financial Solutions, LLC 13
  14. 14. How does the Buyer use thisinformation? With this understanding, the buyer can develop a forward-looking financial picture of the business under the buyer’s management. Determine cash flow from the business with the proposed debt and capital structure. Decide to buy the business or NOT Develop issues for negotiation, terms and conditions. Corporate Financial Solutions, LLC 14
  15. 15. The Due Diligence Plan Must address its goal Should be written Drafted with buyer and key team members Corporate Financial Solutions, LLC 15
  16. 16. The Goal determine the full implications of the proposed purchase or sale of a business;  What are the drivers of the core business? Are we acquiring these?  What drivers aren’t we getting?  What’s included that we don’t want? Must be balanced  for risks and  Impracticalities Therefore the goal is a reasonable investigation for the circumstances Corporate Financial Solutions, LLC 16
  17. 17. Building the due diligence plan Based upon the initial understanding of thebusiness, a plan, unique to the transaction, to conduct the due diligence process must be developed. It must address:  Who  What  Where  When Corporate Financial Solutions, LLC 17
  18. 18. Why do we do this?Ultimately we are seeking to evaluate quality and consistency of earnings and cash flow Corporate Financial Solutions, LLC 18
  19. 19. All financial statements are not created equally Corporate Financial Solutions, LLC 19
  20. 20. WHOThe most knowledgeable persons for the task. • At a minimum the team should include the buyer, the buyer’s management team, accountants and attorneys. • Other experts focusing on environmental, customs, industry specific and real estate issues • Confidentiality is important. Corporate Financial Solutions, LLC 20
  21. 21. WHATDetailed plan is developed to:  identify key business drivers,  validate relevant data,  highlight issues,  access risks. Corporate Financial Solutions, LLC 21
  22. 22. Specifically The Plan addresses the entirebusiness  financial  legal  human resources  sales marketing  operations  tax and regulatory  information technology  Intangibles  Issues specific to company Corporate Financial Solutions, LLC 22
  23. 23. WHEN and WHERE When  agreed upon with the seller Where  should be at the business  at offices of lawyers and accountants  site visits  Retail or market environment Corporate Financial Solutions, LLC 23
  24. 24. The Due Diligence Plan Should be written and agreed upon with the buyer. • The buyer must understand the process • Know what is included and • Know what is excluded from investigation. It can be time-consuming and expensive. Strong representations and warranties can balance the effort but does not replace appropriate due diligence. Corporate Financial Solutions, LLC 24
  25. 25. The Due Diligence Checklist Let’s review a typical checklist used in due diligence. Corporate Financial Solutions, LLC 25
  26. 26. Due Diligence Checklist Planning1. Inquire as to the objectives of the buyer2. Determine why the selling company wants to sell.3. Identify financial objectives of both buyer and seller4. Determine guidelines and lines of communication for conducting discussions about the combination.5. Develop specific plan and responsibilities for the acquisition investigation.6. Review approaches to structuring the transaction considering tax issues, operations issues, capital considerations and ownership issues. Corporate Financial Solutions, LLC 26
  27. 27. Due Diligence Checklist General Information1. Obtain history of the business.2. Obtain a description of the corporate structure.3. Obtain an organizational chart.4. Obtain a list of officers and directors (including backgrounds, affiliations, and compensation).5. Obtain a schedule of stock outstanding and ownership.6. Obtain names and addresses of attorneys, accountants, and consultants.7. Obtain industry statistics for comparison.8. Determine economic outlook of company, its products and the industry.9. List states in which company is licenses to do business. Corporate Financial Solutions, LLC 27
  28. 28. Due Diligence Checklist Marketing1. Who is the Customer?2. List competitors and analyze the competitive position of the company3. Determine the companys market share and market growth.4. Determine the barriers to entry into the market.5. List advantages and disadvantages of the company and its products compared with its competitors.6. Document the history and trends of industry marketing experience, if available.7. Document the advertising and sales policies.8. Prepare a detailed organization chart for the marketing, sales, and advertising departments.9. Determine the costs of marketing and sales10. Review the companys advertising agency and other outside marketing consultants, and their fee arrangements.11. Review methods of distributing the product or service. Corporate Financial Solutions, LLC 28
  29. 29. Due Diligence Checklist Marketing11. List branch offices, warehouses, and service facilities.12. Get sales and volume ranked by customer and by year for at least three years.13. List geographic distribution of sales/customers and salespeople14. Obtain any available market surveys.15. Evaluate the degree of government regulation, including product safety and the company’s history.16. Validate order backlog as compared with historic levels17. List all strategic alliances18. Determine seasonality and sales cycle.19. List trademarks or trade names. Are they properly protected?20. With owners permission, talk with customers. Corporate Financial Solutions, LLC 29
  30. 30. Due Diligence Checklist Operations1. Evaluate the plant, facilities, equipment, engineering and or research facilities.2. Review production and materials-handling procedures and controls.3. Determine the present and projected operating capacity in relation to the market forecast.4. Review expansion plans and the investment required.5. Review inventory storage and distribution procedures and policies.6. Review transportation, inventory and storage facilities.7. Develop plan for evaluating operations specific to the company.8. Determine dependence on sources of supply.9. Determine salvage procedures.10. Determine safety, productivity and efficiency.11. Obtain summary of OSHA inquiries for past three years.12. Obtain summary of federal and state EPA inquiries.13. Obtain copies of all permits and licenses necessary to conduct the Company’s business.14. Evaluate quality of products and services Corporate Financial Solutions, LLC 30
  31. 31. Due Diligence Checklist Information Systems1. Question management and associates about their satisfaction with information systems.2. Determine how this function is supported within the company.3. Has the company identified future hardware and software requirements?4. What is the company’s disaster recovery and other contingency plans?5. Does the company own all of its software, including desktop copies of common software?6. Does the company’s software provide the necessary information to run the business?7. Evaluate the effectiveness of Information Systems within the company.8. Can the company’s software be integrated into the acquirer’s business? Corporate Financial Solutions, LLC 31
  32. 32. Due Diligence Checklist Purchasing1. Obtain a description of the purchasing function.2. Evaluate purchasing policies and procedures.3. List the types of materials and supplies purchased.4. List current vendors and volume purchased by year.5. Determine if company obtains allowable trade discounts.6. Determine outstanding purchase commitments7. Are alternative vendors available for key resources? Corporate Financial Solutions, LLC 32
  33. 33. Due Diligence Checklist Human Resources1. List current employees by department, function and annual salary.2. Review list of employees by department by year for three years.3. Review an employee policies‑and‑procedures manual and determine if followed?4. Inquire as to regulatory compliance5. Determine employee morale.6. Evaluate wage and benefit plans.7. Outline incentive compensation plans.8. Review employee duties, qualifications and vacancies in critical positions.9. Review turnover statistics.10. Consider interviewing key employees11. Review copies of any union contracts and a list of the employees they cover.12. Review all employment, non-compete and confidentiality agreements or contracts13. Summary of all labor disputes for past years Corporate Financial Solutions, LLC 33
  34. 34. Due Diligence Checklist Insurance1. Obtain copies of all current policies and self insurance2. Prepare a three‑year loss and claims experience.3. Obtain information on any outstanding claims, including product warranty; shareholder lawsuits and workers compensation.4. List any insurance changes pending or contemplated.5. List names and addresses of brokers and consultants.6. Evaluate need for loss reserves.7. Investigate need for liability coverage on discontinued products, environmental risks and other catastrophic exposures Corporate Financial Solutions, LLC 34
  35. 35. Due Diligence Checklist Legal Considerations1. Review the corporate charter, minutes, bylaws, and other legal documents.2. List officers, directors, and stockholders.3. List members of special stockholder/director committees.4. Obtain names of inside and outside counsel.5. Determine states where the company is incorporated and/or qualified to do business.6. Review patents, trademarks, and service marks. Are they properly protected?7. Develop a list of the sellers warranties and representations.8. Review all litigation matters.9. Review all current licenses, contracts, and leases.10. Review all loan agreements.11. Review the status of any brokers or intermediaries involved in the merger/ acquisition/sale transaction.12. Review all major contracts, leases, licenses and other agreements.13. Stock vs Asset Sale how does it affect due diligence process? Corporate Financial Solutions, LLC 35
  36. 36. Due Diligence Checklist Financial1. Review financial statements, tax returns, and interim reports for the last five years and monthly for last year.2. Review schedule of all changes in accounting methods or principles during last three to five years.3. Determine financial ratings from credit bureaus and bank sources.4. Review accounting policies and practices, including inventory pricing and valuation methods.5. Review internal control systems and all information systems.6. Review books and records of the selling company7. Review credit policies and collection procedures.8. Itemize properties owned and leased. Evaluate condition and value.9. Itemize all intangible assets of the company, including patents and trademarks. Corporate Financial Solutions, LLC 36
  37. 37. Due Diligence Checklist Financial10. Obtain list of all pledged assets11. Identify all obsolete and slow moving assets to include, receivables, property and equipment, inventory. Evaluate adequacy of reserves.12. Review listing of all liabilities. Understand practices to ensure recording of liabilities are timely and correctly valued. Review historical experience for accuracy.13. Determine contingent liabilities of the company.14. Review the economic outlook for the company, its products, and the industry in general. Collect available financial information on similar companies for comparison15. Confirm normalized earnings16. Identify all related party transactions.17. Identify non-recurring revenue and expenses18. Determine fixed and variable costs19. Review profitability by gross profit; contribution margin; operating profit Corporate Financial Solutions, LLC 37
  38. 38. Due Diligence Checklist Proforma Financial Develop forward looking view of company under new management reflecting results of investigation and management’s plans for business. Determine buyers projected normalized earnings Projected cash available for debt service. Reflect ultimate exit strategy Corporate Financial Solutions, LLC 38
  39. 39. Major issues requiring deep drilling Sale of a division or line of business of a company Sale of a business that is related to other businesses owned by related parties Issues identified in due diligence International Activities Corporate Financial Solutions, LLC 39
  40. 40. International Issues  Cultural  Legal  Language  Management  Cross Border Taxation  Import/Export Duties  In country taxation Corporate Financial Solutions, LLC 40
  41. 41. When does the seller conduct due diligence of the buyer? Seller Financing Consideration is stock  Ted Turner and the sale of TBS to AOL Corporate Financial Solutions, LLC 41
  42. 42. The four key elements involved inthe purchase or sale of a business after the business is identified are: Due diligence and Valuation Tax Considerations of the transaction Capital structure before and after sale Negotiation, terms and conditions & Close Corporate Financial Solutions, LLC 42
  43. 43. What is the relationship between due diligence and business valuation? Business valuation uses the results of the due diligence investigation along with the buyer’s business plan to determine an appropriate offer. Due diligence with Business valuation answers the question: Will the anticipated future benefits (quality and consistency of earnings and cash flows) support the purchase price? Corporate Financial Solutions, LLC 43
  44. 44. Should the Seller Prepare for due diligence? It is an opportunity for the seller to have a reality check. If the seller doesn’t have a realistic assessment of the business, preparing the seller for due diligence can help the seller get there. It may be possible to enhance the selling price by looking at the company as an outsider will look at it Seller should perform due diligence on itself to get ready for the buyer. Corporate Financial Solutions, LLC 44
  45. 45. How can Seller enhance the value of the business?Plan for the sale – just as you fix up your house forsale - fix up the businessAnticipate issues of buyer and address thoseEliminate obstacles to the buyerEliminate/Simplify related party transactionsEliminate unnecessary expenses Corporate Financial Solutions, LLC 45
  46. 46. Seller can enhance the value of the business by - For businesses with multiple revenue sources create line of business financials For businesses with valuable customer/vendor relationships get these in writing and transferable. For businesses in decline bring in a consultant to help business focus on improving business performance Corporate Financial Solutions, LLC 46
  47. 47. Review of Objectives Course Description Identify the Core Business’s Obstacles and Opportunities  Involve all key players in plans and write it down  Have a plan and work the plan  Don’t leave a stone unturned To Prepare the Seller for due diligence  Show the Benefits – maximizing value and realizing purchase price  Have seller perform due diligence on the Company in preparation How can this information be utilized to maximize value for seller  Take corrective actions A brief look at the unique problems of international acquisitions  Bring in experts familiar with international issues Corporate Financial Solutions, LLC 47
  48. 48. Key Takeaways Due diligence is a process of investigating to learn facts Useful in all types of transactions Benefits all parties to the transaction Needs a written, agreed upon plan. Needs a scope appropriate to the transaction. Gets the buyer ready to run the business. Supports the business valuation; supports the tax, capital structure, and terms and conditions of the transaction. Leads to a successful Sale Is foundation for successful business Corporate Financial Solutions, LLC 48
  49. 49. THANKS Debra Pauli, CPACorporate Financial Solutions, LLC Atlanta, Georgia Corporate Financial Solutions, LLC 49