M&A activity is heating up across the TMT sector and I am seeing a stream of transactions within my client base, but 2 recurring themes keep popping up which may scupper that all important deal – an approach or opportunity that arises very unexpectedly, and companies which are just not prepared for the Due Diligence process.
This is particularly important in a hot M&A climate because success often means being prepared, in advance, to move through the deal process in an organised and timely fashion. Being ready and prepared for due diligence is often the pivotal factor in either moving forward, or coming to a full stop.
Owner/Managers of SME companies are receiving a large number of unsolicited inquiries about possible M&A deals. With the improvement in the economy and more predictable forecasts, owners are giving more attention to these inquiries. Some get cast aside, and some trigger a response. One thing I’ve learned is the best opportunity will often appear at an unexpected time.
Being prepared for this moment will create value for the owner, and will enable the buyer to properly evaluate the risks and reach a fair value. During the past year, we’ve seen transactions delayed for preventable reasons including:
- Accounting and tax matters that unexpectedly emerge;
- Inability to produce requested information and documents;
- Appearance of undisclosed commitments and contracts;
- Owners personal activities co-mingled with the operating business;
- Surprises discovered by the buyer that seller should have known about.
A buyer is seeking a detailed understanding of the value drivers, and requires confirming data that such attributes are recognised and sustainable. It’s not hard to know the value drivers. On the other hand, it is difficult to demonstrate these factors without organised financial information and data. This, not surprisingly, is where proper due diligence comes into play, giving both buyers and sellers a layer of confidence in the deal.
Ideally, the due diligence process should be a two-way street where the buyer gets an accurate assessment of the business and accounting practices of the seller, and the seller learns similar information about the buyer. As a starting point, a seller should understand the source of initial valuation for the business, in the form it will be transferred or sold:
- The proxy for initial valuation is often a multiple of Ebitda;
- The Ebitda should be calculated for the transferrable entity;
- The Trailing Twelve Months (TTM) should be prepared monthly;
- The owner should know the relevant comparables and multiples for the industry;
- The balance sheet, and in particular working capital, should be normalized.
Surprisingly, many SME businesses have not considered these initial points. It is more typical for an owner to read an article citing record-level EBITDA multiples for SME businesses, and then rest comfortably thinking this easily applies to his situation. Owners should know that rules of thumb are frequently referred to within the M&A market, but that such examples are not given any weight unless supported by data and confirming information.
Owners should perform mock due diligence on themselves. They should act like a buyer, and dig deeper than a company’s typical internal reporting. There are notable examples where owners have improved deal value by completing mock due diligence exercises to identify and correct deficiencies. In particular, with respect to tax planning, this is truly a case where the greater the lead-time, the more you can do to create value.
Today’s market environment is becoming increasingly complicated, and it is important for both sellers and buyers to be prepared for detailed due diligence. Whether or not a company is for sale, readiness will protect and create value. Whether examining tax, business, or accounting issues, mock due diligence can uncover and investigate potential risks in advance of the opportunity when it someday arrives. A specialised due diligence team can help prepare a company for a transaction, even if a deal is not readily apparent on the horizon.
4oceans can provide both financial and commercial due diligence services to companies that are either in the market for an acquisition or indeed just want to be prepared just in case.
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