Financial due diligence (FDD) is a crucial component in any acquisition, merger, or major investment decision. We understand that FDD goes beyond just verifying the numbers; it provides a clear, objective view of a company’s financial health and helps businesses make informed choices. Whether you’re buying, selling, or investing in a business, financial due diligence ensures you’re fully prepared for what lies ahead.
What is Financial Due Diligence?
In simple terms, financial due diligence is the process of thoroughly investigating and analysing a company’s financial data usually before finalising a transaction. The scope of the financial due diligence exercise can vary based on the needs of the transaction but typically the process would aim to assess the accuracy of financial records, understand the underlying performance of the business, uncover any hidden risks, and validate the assumptions underlying the transaction.
Why is Financial Due Diligence Essential?
1. Informed Decision-Making
FDD provides a comprehensive review of a company’s financial position, allowing you to make well-informed decisions. It reveals insights that might not be apparent from surface-level information, helping you decide whether the deal is worth pursuing and at what price.
2. Risk Mitigation
No business transaction is without risk. Financial due diligence helps identify and quantify these risks, ensuring you aren’t blindsided by unexpected liabilities. Whether it’s tax exposure, hidden debts, or unsustainable cash flow, FDD uncovers potential red flags that can significantly affect the success of a transaction.
3. Price Validation and Negotiation Power
FDD helps you understand the underlying value of the business. By analysing financial projections and historical data, you can confirm that the offer price reflects the true value of the company. If, following FDD, the value of the business appears lower than initially expected you have leverage, backed by data, to renegotiate the offer price.
The Key Benefits of Financial Due Diligence
A thorough due diligence process can transform the outcome of a business deal. Here’s how:
- Comprehensive Risk Assessment: FDD helps you understand all financial risks involved, from customer / contract dependency and key person risk to tax obligations and other long-term liabilities. By identifying these risks early, you can take proactive measures to protect and de-risk your investment.
- Validation of Key Assumptions: Many deals are valued on future growth and profitability. FDD assesses these assumptions to ensure they are realistic, considering the company’s historical performance, known and / or expected changes and industry trends.
- Identifying Value Drivers and Synergies: Beyond risks, FDD can uncover hidden strengths in the target business, such as untapped market potential or operational efficiencies, which can be capitalised upon post-transaction.
- Strengthened Negotiation Position: Equipped with detailed financial insight, you’re in a much stronger position to negotiate favourable deal terms, from adjusting the purchase price to demanding certain warranties or indemnities. In some cases, you may even feel it is necessary to walk away from the deal.
When Should You Conduct Financial Due Diligence?
FDD is vital in any business acquisition, merger, or investment, whether it’s a small enterprise or a multi-million-pound corporation. It’s also beneficial in cases of significant partnerships or joint ventures, where a clear understanding of the financials is essential for success.
What Does Financial Due Diligence Involve?
A comprehensive FDD process typically includes:
- Assessment of the quality of earnings: Review the financial statements and supporting management information and assess the historical and current performance of the Company, including Key Performance Indicators. Review the quality and sustainability of underlying profits, including identification of non-recurring or one-off items.
- Quality of net working capital and net cash / debt: Analyse the underlying net working capital requirements needed to run the business efficiently post-acquisition and assess any off-balance sheet financing. Review the level of free cash or debt in the Company which typically impacts the total proceeds paid to the Sellers.
- Tax Compliance and Liabilities: Ensure all taxes have been accurately reported and identifying any outstanding tax obligations.
- Forecasts: Review the robustness of the financial projections and how they compare to historical and current results.
- Accounting function and management systems: Evaluate the quality of financial information and review of historical budgeting accuracy. In addition, consider future suitability of monthly financial reporting for the Buyer or Investor in respect of timeliness and level of data produced.
At Menzies, our approach to FDD is tailored to each transaction. We dive deep into the financials to provide you with a complete understanding of the target company’s financial position, risks, and growth potential. Our experienced Deal Advisory Team guides you through every stage of the process, ensuring you’re equipped to make the best decision.
By offering a detailed analysis of the company’s historical financials, working capital requirements, and future projections, we help you navigate the complexities of the transaction and give you peace of mind before finalising the deal.
We can also support you by leading the final negotiations in respect of either the price paid for the target, and/ or the cash free, debt free adjustment following the FDD process. This can help protect the relationship between the buyer / investor and seller, especially where their involvement post completion is critical to the long-term successful outcome of the transaction.
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