M&A Due Diligence Checklist: Be Proactive & Prepared
Due Diligence is a crucial step in the M&A process; this checklist will help you prepare.
Due Diligence can be a time consuming process. One of our partners, LB&A, Certified Public Accountants has created a checklist to help business owners going through the M&A process. Many times CPAs just look at due diligence as: “I’ll take three years of tax returns and financials and see if they make sense.” That’s just a sanity check. If you can’t get past that, you do not want to buy the business. But if you make sound decisions as the new owner, you will need a lot more information, than just the financials and tax returns!
Let’s take a close look at the checklist, which examines the wide range of issues involved in a M&A transaction.
- Nondisclosure Agreement: In negotiations, each party will be revealing a lot, and this agreement protects both the buyer and seller. The seller wants to know if the buyer will be a good fit for its clients and will be asking plenty of questions to get to the heart of the buyer’s way of doing business. If the acquisition fails to go through, that information potentially could be used by the competition. The nondisclosure agreement helps protect against that.
- Three Years of Tax Returns: This seems basic, but the first financial piece a CPA wants to see is three years of tax returns. These substantiate the fundamentals. The tax returns are a good starting point for buyers to see if what they’ve been told is close to reality.
- Revenue by Month for Three Years: You can see the revenue peaks and valleys that the company has. Perhaps their busy season is different than yours, so the merger would result in a perfect sharing and shifting of employees. You can learn a lot on how to plan and how to staff your team by looking at the revenue trends.
- Salaries Per Person: Pay discrepancy can be an issue. Make sure you have upfront conversations so you can make sense of any pay issues. This will decrease surprises and keep morale up.
- Staff Duties: Make sure you know the staff you are taking on. Know their roles and how defined they are. CPAs love to see resumes from the company that is being acquired. You might see an abundance of talent and ask how the company manages to attract such people. Also you could have employees that fit better in other roles – maybe one has a finance degree and could become your internal bookkeeper, maybe one would be better serving clients or would be great at marketing. Knowing your staff is key!
- Average Raises: What have the average raises been for the last few years? If your staff is used to 2% raises and the new staff is used to 6% raises, somebody is going to be surprised next year, one way or the other. Have these discussions upfront.
- Bonus Structure: Do the buyer and seller differ on performance-based compensation? Do such bonuses depend on specific goal-setting, accountability, or targets throughout the year? Is that bonus clearly defined? Make sure you ask the right questions from the start so you don’t get lots of wrong answers later.
- Benefits: Do the buyer and seller offer the same benefits? What retirement plans are offered? Does one have a 401(k) and the other a Simple IRA? How about health, disability, or life insurance? What is the coverage for those sorts of benefits? They’re important to people these days!
- Hourly Billing Rate per Person: If you are acquiring a consulting firm or a law firm or a web design firm or any sort of consulting or professional service industry, generally they bill hourly rates or they track hours and try to get a rate per hour for each individual. You want to make sure those are in line with yours – otherwise the hours and rates charged to clients won’t line up.
- HR Policies: Who hires new people? Who does the interviewing? Is there an employee manual or handbook? What does it say? These questions are important as you go though due diligence because you want to make sure that the cultures of human resources line up.
- Paid Time Off: After you merge, it’s hard to run two different paid time off plans. It’s much easier to just go with best practices and agree that one of you will change.
- Owner Perks: Little things such as meals and entertainment and travel and disability and health quickly become sizable when you add them up, so remember that owner-discretionary expenses won’t necessarily be your own expenses.
- Other Insurances: What is being done with workers compensation liability? What about general liability, professional liability, any sorts of liability that the buyer or the seller may have? You want to understand the risks that you may continue to carry.
- Software: It’s important to understand software and the costs involved. If you think you will keep yours but learn that you need the other company’s software, you could face an expensive upgrade. Getting a handle on that ahead of time is always better than being surprised at the last minute.
- Services Performed: What types of services does the other company perform? Is it in the same industry with the same product mix? You may have a product or service that you could offer these new clients, whereas the seller didn’t have that opportunity.
- Time Reports for Three Years: Time reports are especially important for service companies. You are able to learn a lot about the other company’s culture by looking at the other company’s work hours.
- Receivables: Specifically, under receivables, you’d like to look at the aging of those receivables, meaning how long the receivables have been out and not collected. This could potentially change your line of credit, but you won’t know unless you’ve seen the numbers, planned for them and made some decisions based on them.
- Collection Policies: How does the other company collect? Does it take credit cards? You might lose 2-3% on a credit card, but you could get your money upfront, rather than wait on payment terms of 30, 60, 90 days.
- Billing Policies: The buyer and seller need to come to terms over who has the better practices, who collects money faster; who’s able to turn receivables into cash in the bank more quickly and who has a better policy on billing and credit.
- List of Equipment and When Purchased: You might be in heavy manufacturing, landscaping or IT. Understanding what the capital investment might be as a new owner is important. The need for a giant investment on top of all your other changes can be daunting.
- References: Check with the BBB or other sources to reassure yourself that the other party is reputable and that its clients don’t just use it because they have little choice. If you have a pristine reputation in the community but the seller doesn’t, you could tarnish your own name through the purchase.
- Startup Cash Needed: You need to understand the cash needed up front. That doesn’t mean finding out whether the business will be profitable, you should already know that it is or else you wouldn’t be buying it. Profit does not equal cash. Sometimes the cash takes a little bit longer to kick in.
- Inventory: Understand how much investment you will have in the inventory that you’re carrying and how long it is going to sit.
- Research: Consider doing ratio analysis and industry data, particularly if you’re unfamiliar with the industry of the company you are acquiring. Risk Management Association is a good resource for this.
- Bank Debt: What does the company’s bank debt look like? If it’s a stock deal, you may or may not be absorbing its bank debt.
This due diligence checklist is meant to be a guide. It doesn’t mean that every single one of these items has to be in perfect condition. It just means that you have to prepare for whichever ones are not and make sure that you’re making decisions for the combined company in a correct way. These are the elements that make an M&A deal go smoothly, or not so smoothly. If you are prepared, you will see those rough spots for what they are. You will deal with issues and put them in proper perspective. If you’re not prepared, expect surprises.
This was a guest post by our friends at LB&A.
LB&A, Certified Public Accountants, PLLC is a full service accounting firm with offices in Charlotte, NC and in Greensboro, NC. LB&A provides value-added services throughout the service delivery process to improve operations and ensure compliance with relevant regulations. LB&A takes a strategic and holistic approach to accounting that looks at more than just your business tax situation. LB&A works to understand your finances, your culture, your goals, and your aspirations. With this comprehensive understanding of your organization in place, LB&A is able to provide the best possible service, helping you protect and improve your organization’s fiscal health and well-being — for now, and for the future.
To learn more about LB&A visit https://www.lba-cpa.com.