How to perform your Due Diligence for Mergers & Aquisitions

If you've identifed a competitor looking to sell or perhaps a possible vertical alliance with a supplier then you'll need to do your homework, or 'due diligence' to establish the viability of the deal now and into the future.

Due Diligence is a complex process that involves digging much deeper than you'd expect - our advice would be 'don't go it alone' as it could cost you your own business if you make the wrong decision.

Having said that -

There's never been a better time to be looking for such opportunities so here's a guide to how much you really need to know about another business before you can call your decision an informed one.

Getting a Snapshot from their Financial Statements

What to look for in the Balance Sheet - Assets & Liabilities

• Cash and Marketable Securities as a percentage of current assets.
• Accounts Receivable by amount,  age and bad debt experience.
• Inventory classified as raw materials, work in progress and finished goods.  Inventory turnover and method of valuation.
• Size and nature of Prepaid Expenses.
• Fixed Assets (property, plant and equipment). If owned, the dates of acquisition, accumulated depreciation, and residual values. If leased, by type of lease (finance or operating), details of lease agreements, and the method of capitalization.
• Intangible Assets such as patents, copyrights, goodwill, and the methods of amortization.
• Accounts payable amount as a percentage of total liabilities.
• Long-Term Debt classified by amount, interest rates, and due dates.

• Unrecorded and contingent liabilities.

What to Check for in the Profit and Loss Statement - Income & Expenses

• Sales by revenue stream.
• Direct variable materials, labour, and direct fixed overhead costs by revenue stream.
• Gross margin by revenue stream.
• Fixed selling, operating and administrative as a percentage of total sales.
• Other Income (interest, rents, royalties), amount and stability.
• Other Expenses (interest).

• Tax expense/benefit.

By now you might be thinking - I don't even have this much information about my own business! What you need to remember here is that the business you're looking a aquiring or merging with has been founded and built by someone else - someone who may have completely different ideas and values when it comes to running a business. If you don't complete the next part of the process - you could get a rude shock down the track.

For example: The company you're looking to aquire may currently have a large contract with a Blue Chip company that you're keen to do business with - what happens if you buy the company and they decide not to renew the contract in 18 months time?

Are there other revenue streams to make up the short fall?

Now it's time of Dig a bit Deeper - Future Growth, Competition, Technology etc

Closer Examination of Current & Future Revenue Streams

Revenue Stream Characteristics

• Volume of each revenue stream over the relevant time period.
• Growth potential of each revenue stream.
• Estimated future life span of each revenue stream and point on the life cycle.
• Competition from direct competitors and substitute revenue streams.
• Affect of economic and seasonal fluctuations on each revenue stream.
• Any patents or licenses related to each revenue stream.
• Services accompanying sales revenue stream such as repair and maintenance.

Technological Characteristics

• Production technology for each revenue stream.
• Commonalities technologies used by different revenue streams.
• Opportunities to use the acquired technologies for additional revenue streams.
• Compatibility of the acquired technologies with those of the acquiring business, and the extent to which economies-of-scale can be enhanced by the acquisition

Competition

• Market share of each revenue stream.
• Servicing a regional, national, or international market
• Principal competitors and whether any of them have advantages in terms of access to or ownership of particular factors of production.
• Sensitivity of each revenue stream to advertising expenditures, price changes, and other promotional strategies.
• Quality of the business’ short and long forecasting of sales and earnings.

• Human Resource Development

Professional Personnel - Know who & what you're Dealing with

• Key professional employees (engineering, chemist, accounting, and legal) by department and revenue stream.
• Remuneration structures of professional personnel.
• Any potential points of friction among the professional personnel.
• Any potential redundancy. 

• Impact of any individual or union contracts.

Labour Force - What it's going to Cost to get the job done

• Size, length of service, and wage distributions of labour force.
• Breakdown of labour costs by revenue stream and department.
• Type and cost of fringe benefits.
• Scale of compensation compared to industry surveys.
• Is there a union and what are the specific provisions of any agreements?
• History of labour relations.
• Consider the affect of the combination on the employees and methods of managing employees through the business combination.

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