issues during the due diligence process in m&a transactions

Completing a due diligence analysis is a critical step in the M&A process. Due diligence is conducted to validate value proposition assumptions, evaluate strategic and financial risks, and support deal decision making. Many times, there are issues that arise in these findings that may negatively impact a deal going through.

Here are a few common issues found during the due diligence process:

• High customer concentration
• Overstated EBITDA add-backs
• Working capital issues
• Unsustainable growth projections
• Low EBITDA margins
• Unusual revenue swings
• Inaccurate financial statements
• Top management weakness

“I’ve seen many of these issues arise during the due diligence phase of different M&A transactions. The most common issue revolves around working capital.  Typically the definition and calculation of the ‘working capital peg or target’ is addressed late in the sale process during purchase agreement negotiations.  Many times this leads to disagreements which is why we strive to address working capital expectations with buyers as early in the process as possible,” said Lutz Consulting and M&A Shareholder, Bill Kenedy.

Although these are common issues, not all transactions are subject to negative findings. Here are a few things to keep in mind to help you prepare your business for a clear due diligence analysis:

1. Know that a buyer will want to make themselves comfortable that your company is sustainable. Meaning your business doesn’t have any significant risk to future sales, profitability and growth.

2. A buyer will want to confirm that your company’s financial performance is as good as you have portrayed it to be. With this in mind, know that they will check every aspect of your performance, including confirming revenues, costs and EBITDA adjustments.

3. Companies with audited or reviewed financials tend to have a better due diligence experience than those without CPA prepared quality financials.

4. If you have a large customer that will be hard to replace, this will typically reduce the amount buyers are willing to pay.

5. If there are gaps in your management team, your company’s EBITDA will be negatively adjusted for the cost of hiring and compensation of new executives.

Issues uncovered during due diligence may result in change of deal terms and could prevent a deal from closing. So, it’s important to consider these factors when deciding to sell your business.

With proper preparation, negative surprises during the due diligence process can be eliminated. If you have questions concerning the due diligence process of an M&A transaction, please contact Lutz M&A.