Key Takeaways
- Due diligence allows you to find less obvious opportunities, risks, and threats that could impact a potential deal.
- Red flags found throughout due diligence might influence you to lower your offer, insert safeguards into the purchase agreement, or walk away from the deal altogether.
- Your active involvement in the due diligence process will help you gather critical insights and address any issues promptly.
Whether you’re looking to expand your business, broaden your geographical presence, or diversify your service offerings, acquiring another organization is an effective strategy for growth.
However, studies report that approximately half of all deals fall apart due to the buyer uncovering issues the seller didn’t previously disclose.
Buy-side due diligence is a critical component of preparing for the merger and acquisition process and ensuring a successful outcome.
What is Buy-Side Due Diligence?
Due diligence is an evaluation process that ensures all information associated with a deal — financial, operational, tax, IT, HR, etc. — is properly considered prior to purchase. Performing due diligence allows you to make an informed decision about a potential acquisition and develop terms you feel comfortable with.
While audits and financial statements can offer helpful information about a company, they don’t provide a comprehensive picture of the business. Due diligence allows you to find less obvious opportunities, risks, and threats that could impact the deal.
Due diligence enables you to assess key risks and opportunities involving the target company’s quality of earnings, cash flow, assets, liabilities, and working capital.
Engaging in buy-side due diligence also prompts you to address critical questions such as:
- Do you fully understand the target’s reliance on a specific customer, vendor, or product, and how this concentration might impact you in the future?
- Are there any one-time events in revenue streams that could be artificially inflating historical earnings or cash flow? Have there been recent changes in the cost structure?
- Is there an existing order backlog, or are there minimum sales or purchase requirements in current contracts?
- What tax liabilities will you assume if you proceed with a stock or unit acquisition?
- Can the target's current technologies meet projected needs, or will significant additional investments be necessary post-acquisition?
Red flags found throughout this process might influence you to lower your offer, include more considerations in earn-out targets, insert safeguards into the purchase agreement, or walk away from the deal altogether.
- Several factors can influence a company’s quality of earnings. Learn more about what you can expect to uncover in our Essential Guide to Due Diligence.
Understanding the Buy-Side Due Diligence Process
Acquiring a business starts with identifying a potential target. Once a target is identified, the due diligence process begins. Here's what the process may include:
Initial Review and Information Request
Begin by gathering and reviewing the target's preliminary information. This might include financial statements, operational reports, and any other relevant documents. Identify any additional information needed and request these items from the target company.
Engage Third-Party Professionals
The next step is to select a third-party vendor, typically a CPA or business advisory firm, to perform due diligence. It's essential to select vendors with a strong track record in due diligence and a proven methodology. These individuals will help scrutinize various aspects of the deal and address key concerns.
Define the Scope of Work
Collaborate with your chosen vendor to outline the specific areas you will investigate. Each deal is unique, so tailor the due diligence to fit the intricacies of the acquisition.
Typical buy-side due diligence will include the following review and analysis:
- Quality of earnings report
- Revenue and margin concentrations
- Add-backs and EBITDA adjustments proposed by seller
- Significant estimates
- Normalized working capital
- Tax matters, including state, sales and use, and local tax reporting
- Cybersecurity considerations
- Technology limitations
- Other diligence areas, including legal, environmental, human resources, insurance, etc.
Depending on the target company, due diligence may also seek to gather:
- A financial analysis to better understand daily operational and financial questions
- A forensic examination and/or background checks to understand the risks associated with your potential acquisition
- An analysis of the tax ramifications of the sale
Coordinate with the Target’s Advisors
Arrange an introduction to the target's CFO or sell-side advisor. These advisors will facilitate the due diligence process on behalf of the target. At this time, you will also need to provide your advisor’s data request list and establish a timeline for the due diligence process.
Review and Discuss Findings
The financial and tax due diligence typically takes three to five weeks. Once the draft report is ready, you will have a detailed discussion with your advisor about the findings. These insights may impact deal terms, historical performance assessments, and future earnings projections.
Additional Due Diligence Considerations
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Stay actively involved in the due diligence process.
Participate in calls, meetings, and site visits to ensure you are fully informed. Your involvement will help you gather critical insights and address any issues promptly.
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Conduct a thorough review of the target’s IT systems and infrastructure.
Assess the quality, reliability, and scalability of their technology to ensure it can support future growth and integration with your systems. Identify any IT-related risks, such as outdated systems or cybersecurity vulnerabilities.
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Be aware of Environmental, Social, and Governance (ESG) factors.
With recent updates to corporate reporting standards, many businesses are focusing on ESG efforts within potential acquisitions. Consider how well the target’s ESG practices align with your organization’s values and sustainability goals.
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Utilize the intel acquired to ensure post-acquisition success.
The due diligence process will help you understand the driving factors important to ensuring future stability and growth. With this information compiled, you should be better equipped to make informed decisions as you take the company forward.
Strategic Transactions Rely on Preparation and Information
Buy-side due diligence is a vital step in the acquisition process, empowering you to make well-informed decisions. By thoroughly evaluating financials, operations, IT systems, and other factors, you can identify opportunities and mitigate risks, setting the stage for a successful transaction.
At Eide Bailly, we specialize in guiding clients through the complexities of due diligence. Our experienced team of Certified Merger and Acquisitions Advisors and Certified Public Accountants dedicate 100% of their time to due diligence and quality of earnings projects. Wherever you are in your transaction journey — we can help.
