Frequently Asked Questions
Acquisition due diligence
What is financial due diligence?
A financial due diligence is a process through which a potential acquirer evaluates a target company or its assets for acquisition. It involves the performance of an investigation of a business and provides peace of mind to a buyer by analysing and validating all the financial, commercial, operational and strategic assumptions being made by the seller. Finally, it uses past trading experience to form a view of the future and confirm whether or not there are any "deal breakers" for the proposed transaction.
Why should I do a financial due diligence? Is it important?
A financial due diligence is a fundamentally key element of the pre-acquisition transaction process. It identifies the critical success factors for the acquisition and describes the relevant issues so that an informed decision can be made. It also highlights strengths that can be built upon and weaknesses that can or can't be resolved. External events are often outside a company's control but their impact can be minimized if proper financial due diligence is performed. The more time spent on financial due diligence, the higher the probability of achieving a successful outcome.
Although many securities laws worldwide do not directly refer to the term "due diligence" per se, most mandate a certain level of financial due diligence with respect to securities. Since many mergers involve the exchange of securities, the so-called "due diligence" portion of this law is particularly important for an acquirer to master. Therefore, all of these financial due diligence efforts are applicable to M&A financial due diligence, when an acquirer is looking to buy the shares or the assets of another company. In addition, companies listed on the South African JSE Securities Exchange have to comply with King II (King Report on Corporate Governance for South Africa published in 2002) which sets out standards for good corporate governance. A company's corporate governance standards are often measured by the quality of the financial due diligence process which precedes an acquisition.
Why should I use independent professionals to do my financial due diligence? Can't I just do it myself?
The JSE Securities Exchange requires that any company involved in a merger or acquisition undertakes a financial due diligence.
Execution of a financial due diligence investigation should be carried out by a team of industry-focused professionals with the requisite transaction and industry knowledge to identify the hidden value and risk in the proposed transaction. By using independent professionals, the purchaser is forced to view the purchase in a clear and objective manner, eliminating emotions that often get in the way.
What answers should a good due diligence provide?
- Is the information provided by the target, on which you are basing your investment decision, reliable?
- Are the historical earnings of the company sustainable?
- What are the potential future earnings of the company?
- How comfortable are you that reports profit turn to cash?
- What are the possible synergies associated with the proposed transaction?
- What are the immediate and future tax consequences of the proposed transaction?
- Is the purchase price reasonable given the result of the due diligence process?
- Are there any "deal breakers"?
- Is the structure of the transaction appropriate?
- What protections should be sought as part of the deal process (warranties and indemnities)?
Vender Due Diligence
What is vender due diligence?
Vender due diligence is an independent and thorough review of a business being offered for sale. It is commissioned by the vender but is designed to provide a detailed assessment of the business and is intended to answer questions that could potentially be asked by a buyer.
What value is there is commissioning a vender due diligence report?
Vender due diligence can make an important contribution to the achievement of a successful sale. Designed for sending to prospective buyers, the document contains vital information from unbiased experts. Aimed at generating better informed bids and reducing the risk of future price reductions, they also highlight early in the process, issues which could affect not only price but the deal itself.
- What are the benefits from the vendor due diligence process?
- It helps the vendor maintain control of the sale process.
- Potential problems are highlighted early in the deal so that they can be resolved before purchasers have access to the business and can be presented in a balanced manner.
- It minimises disruption to the business by reducing the need for purchasers to conduct their own due diligence.
- It is understood by the market as an independent report – ultimately it is signed over to the purchaser.
- It ensures that commercially sensitive information is disclosed in a controlled manner.
- It maintains competitive tension during the sale/auction process and helps maximise price.
Purchase Price Allocation (PPA)
What is PPA?
Purchase price allocation is the process of assigning fair value to all major assets and liabilities of an acquired enterprise following a business combination in accordance with IFRS3: Business Combinations.
Why does it need to be done?
Current accounting standards such IFRS and US GAAP require that all assets and liabilities, including intangible assets, are fully identified and accounted for separately from goodwill. IFRS and US GAAP also require that the acquirer allocate goodwill to specific assets of the target.
In addition, PPA adds greater transparency to the acquisition process by helping to indentify and value the assets being acquired in order to determine the net residual amount attributed to goodwill.
Why should I use independent professionals to do my PPA? Can't I use my auditor or just do it myself?
Various non-audit services may not be provided by a firm's auditor as it could impair their independence. Services specifically excluded include appraisal and valuation services or any process that involves the valuing of assets, both tangible and intangible, or liabilities. Therefore, even though a company's auditors may be qualified to perform a PPA, due to reasons of independence, they are prohibited from doing so.
PPA can be performed in-house but even large organisations may not have the required expertise as it is not something they do every day.
The best option is to employ an independent professional. This alternative provides more certainty with respect to the PPA process and, more importantly, allows management to focus on more strategic post-acquisition challenges.
Assigning fair value to the tangible and intangible assets and liabilities of a newly acquired business enterprise requires the skills of qualified valuation professionals. Subjectivity is involved in PPA with estimating the future value potential of brands, technology, customer relationships and goodwill. In addition, the amount of goodwill recognized by the acquirer could impact its future earnings should there be future impairments of goodwill. It is therefore critical for the acquirer to ensure that the PPA process is correctly performed.