“Making due diligence work work for you” by Renato J. Galve (June 13, 2011)
Business World (06/14/2011), Page S1-3
The title of the Suits the C-Suite column published on Monday, written by Renato J. Galve, should have read: “Making due diligence work work for you,” instead of “Making due diligence work for you,” since “due diligence work” itself is a type of service.
SUITS THE C-SUITE By Renato J. Galve
Business World (06/13/2011)
Companies expanding inorganically find challenge in making due diligence (DD) reviews generate the answers needed to make the right decisions on corporate acquisitions.
Experience shows that companies that invest in having their own internal competent DD team to work with independent professional consultants are best equipped to come up with the right answers to the questions on the acquisition, and therefore the right decisions.
Management is tasked to evaluate whether an acquisition makes sense, considering its own current business and its long-term goals.
Not all of the answers can be had at the outset; most are obtained as a result of a review of the target’s business and financial affairs. When management does make a decision that a deal makes sense, it must then determine the right price for it, i.e., the price at which the acquisition will generate the desired returns for the company.
The valuation exercise can actually be done at the early stage and then later confirmed by the results of the DD work. Final valuation takes into account the findings of the DD work that affect the values of assets and liabilities of the target, its current or future earnings, and future cash flows.
Management will do well to discuss with the DD team the selected valuation approach so that the team can take this into account in the course of its work. For example, if the approach uses a multiple of EBITDA formula, the team can then work to include comments on what items need to be considered to arrive at the adjusted normalized EBITDA for use in that formula.
An acquisition is normally a large transaction and a major deal for the acquirer. Considering the risks and the amounts involved, it is best for the acquirer to get advice and assistance from professional consultants, including financial and tax DD experts, legal counsels, technical experts, property appraisers, actuaries and other consultants. As part of their good governance policy, the basic requirement for some companies is to engage independent consultants to assist the internal team in the DD work. The right DD team (internal team and their external advisers) can even challenge the rationale for the acquisition and help identify issues and other considerations that will help management decide on the deal and then negotiate with the seller for the right price. This team can also advise on the terms and conditions to include in the sale and purchase agreement the matters that need attention prior to financial closing and those that need to be addressed post-closing. A properly planned and executed DD review will identify deal breakers or confirm the benefits that the buyer is pursuing in the transaction.
DD work can be a very tricky exercise. It is not difficult to lose sight of some issues in the course of doing this work and it pays to have more heads involved in analyzing the transaction and come up with the right analyses and the issues to deal with.
With professional consultants providing support, management and its own DD team can have the opportunity to validate their own views and findings, look at issues from other angles or points of view, consult on accounting and tax matters that need to be addressed professionally and assess the impact of legal issues and other business exposures. Some issues that are properly accounted for in accordance with existing financial reporting standards may have to be dealt with differently in an acquisition in view of their impact on valuation. Another issue to address would be related party transactions and their impact on future operations if replaced with arms length contracts.
In the local environment, given the complexity of tax regulations, it is not uncommon for tax DD work to identify substantial tax exposures of certain targets. It is then necessary to assess how these exposures can translate to future tax assessments. It is therefore necessary to have professional tax consultants look not only into tax compliance but, more importantly, into communications with tax authorities, recurring withholding tax and value-added tax issues raised during annual audits of the Bureau of Internal Revenue, related party transactions and characterization of revenues and expenses. This transaction-focused exercise will assist the buyer in understanding the contingent issues that may affect the target’s future operations. The consequences of ignoring this area can make the acquisition financially disastrous to the buyer.
A DD review conducted by a professional independent team is not meant to be an audit but rather an exercise involving business and analytic reviews of the target’s financial operations. It focuses on identifying relevant and significant transaction issues that matter to the buyer, rather than conduct procedures to validate specific accounts in the financial statements. However, while the result is giving the buyer relevant deal advice, a DD review can also highlight areas in the target’s accounts that may need to be subjected to specific attest-type procedures agreed upon to provide specific assurance on those accounts. Attest work will normally be limited to the factual results of applying the attest procedures in accordance with the requirements of the applicable attest standards. It will not include providing insights and other comments on a wide range of issues that are possible under an advisory engagement, such as commenting on the target’s financial projections, the sale and purchase agreement and other areas that the buyer may request the DD team to look into.
An independent team of financial and tax consultants, using a proven and well-established methodology for performing DD reviews, can provide a buyer with tremendously useful and significant insights, comments on and analyses of the target’s business and financial affairs. The corporate planning or internal M&A team of an acquiring company is well-advised to engage such an independent professional team as this arrangement will go a long way in making their work far better in terms of results that drive key management decisions on their acquisitions.
(Renato J. Galve is a Partner and the Head of Transaction Advisory Services for SGV & Co.)
This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.