Certified Public Accountants and Consultants


Financial Due Dilligence

If you are looking to acquire a concern to increase your presence in the markteplace,  or for any other reason, we can help.   We offer acquisition analysis and financial due dilligence services.   There are a number of ways to complete and acquisition whether it be for cash stock of via a loan.  We can help you decide on which is best for you.   There several ways to calculate the value of a potential target.   They are as follows:

Market Approach - Sales Based

Compare the company's revenue to the sale prices of other, similar companies that have sold recently. For example, a competitor has sales of $3,000,000 and is acquired for $1,500,000. This is a 0.5x sales multiple. So, if the owner's company has sales of $2,000,000, then the 0.5x multiple can be used to derive a market-based valuation of $1,000,000. However, there can be some problems with this approach. First, the company that has already been sold might have had substantially different cash flows or profits; or, the acquirer might have been paying a premium for the intellectual property or other valuable assets of the acquiree. Consequently, only use this valuation formula if the comparison company is quite similar to the owner's company.

Market Approach - Profit Based

 Compare the company's profits to the sale prices of other, similar companies that have sold recently. For example, a competitor has profits of $100,000 and sells for $500,000. This is a 5x profit multiple. So, if the owner's company has profits of $300,000, then the 5x multiple can be used to derive a market-based valuation of $1,500,000. However, profits can be fudged with aggressive accounting, so it can make more sense to calculate a multiple of cash flows, rather than profits.

Income Approach 

Create a forecast of the expected cash flows of the business for at least the next five years, and then derive the present value of those cash flows. This present value figure is the basis for a sale price. There can be many adjustments to the projected cash flows that can have a profound impact on the present value figure. For example, the owner may have been paying himself more than the market rate, so the acquirer will be able to replace him with a lower-cost manager - which increases the present value of the business. Or, the owner has not been paying enough for discretionary items, such as fixed asset replacements and maintenance, so these additional expenditures must be subtracted from the projected cash flows, resulting in a reduced present value. These types of issues can result in a significant amount of dickering over the valuation of a business.
Asset Approach

Calculate the market values of the company's assets and liabilities. Add to these amounts the assumed value of internally-generated intangible assets, such as product branding, customer lists, copyrights and trademarks. The sum total of these valuations is the basis for the value of the business. In many cases, the value of the intangible assets exceeds the value of the tangible assets, which can result in a major amount of arguing between the buyer and seller over the true value of these assets.

We can help you decide on which approach will work best for your acquisition.

Acquisitions involve  substantial due diligence by the buyer.   The buyer needs to ensure that it knows what it is buying and what obligations it is assuming, the nature and extent of the target company’s contingent liabilities, problematic contracts, litigation risks and intellectual property issues, and much more. This is particularly true in private company acquisitions, where the target company has not been subject to the scrutiny of the public markets, and where the buyer has little (if any) ability to obtain the information it requires from public sources.
The following is a summary of the most significant legal and business due diligence activities that are connected with a typical M&A transaction. By planning these activities carefully and properly anticipating the related issues that may arise, the target company will be better prepared to successfully consummate a sale of the company.
Of course, in certain M&A transactions such as “mergers of equals” and transactions in which the transaction consideration includes a significant amount of the stock of the buyer, or such stock comprises a significant portion of the overall consideration, the target company may want to engage in “reverse diligence” that in certain cases can be as broad in scope as the primary diligence conducted by the buyer. Many or all of the activities and issues described below will, in such circumstances, apply to both sides of the transaction.

Financial Matters to Consider

The buyer will be concerned with all of the target company’s historical financial statements and related financial metrics, as well as the reasonableness of the target’s projections of its future performance. Topics of inquiry or concern will include the following:

  • What do the company’s annual, quarterly, and (if available) monthly        financial statements for the last three years reveal about its financial     performance and condition?
  • Are the company’s financial statements audited, and if so for how long?
  • Do the financial statements and related notes set forth all liabilities of  the company, both current and contingent?
  • Are the margins for the business growing or deteriorating?
  • Are the company’s projections for the future and underlying                        assumptions reasonable and believable?
  • How do the company’s projections for the current year compare to         the board-approved budget for the same period?
  • What normalized working capital will be necessary to continue                  running the business?
  • How is “working capital” determined for purposes of the acquisition       agreement? (Definitional differences can result in a large variance of     the dollar number.)
  • What capital expenditures and other investments will need to be              made to continue growing the business, and what are the company’s      current capital commitments?
  • What is the condition of assets and liens thereon?
  • What indebtedness is outstanding or guaranteed by the company,           what are its terms, and when does it have to be repaid?
  • Are there any unusual revenue recognition issues for the company          or the industry in which it operates?
  • What is the aging of accounts receivable, and are there any other             accounts receivable issues?
  •  Should a “quality of earnings” report be commissioned?
  • Are the capital and operating budgets appropriate, or have                           necessary capital expenditures been deferred?
  • Has EBITDA and any adjustments to EBITDA been appropriately             calculated? (This is particularly important if the buyer is obtaining            debt financing.)
  • Does the company have sufficient financial resources to both                      continue operating in the ordinary course and cover its transaction        expenses between the time of diligence and the anticipated closing         date of the acquisition?

Other Matters to Consider

  • Technology/Intellectual Property
  • Customers/Sales. 
  • Strategic Fit
  • Material Contracts. 
  • Employee/Management Issues
  • Litigation
  • Tax Matters. 
  • Antitrust and Regulatory Issues
  • Insurance

For More Information Please Call Us for a Free Consultation

Steps in an Acqusition

After the target entity is identified a letter of intent is signed by the aquireor and the targe. The letter of intent generally does not bind the parties to commit to a transaction, but may bind the parties to confidentiality and exclusivity obligations so that the transaction can be considered through a due diligence process involving lawyers, accountants, tax advisors, and other professionals, as well as business people from both sides.

After due diligence is completed, the parties may proceed to draw up a definitive agreement, known as a " merger agreement" " share purchase agreement" or " asset purchase agreement" de pending on the structure of the transaction.   Such agreements are typically 80 to 100 pages long and focus on five key types of terms:

Conditions , which must be satisfied before there is an obligation to complete the transaction. Conditions typically include matters such as regulatory approvals and the lack of any material adverse change in the target's business.

Representatio ns and warranties by the seller with regard to the company, which are claimed to be true at both the time of signing and the time of closing. Sellers often attempt to craft their representations and warranties with knowledge qualifiers, dictating the level of knowledge ap plicable and which seller parties' knowledge is relevant..    If Guarranties by the seller prove to be false, the buyer may claim a refund of part of the purchase price, as is common in transactions involving privately held companies (although in most acquisition agreements involving public company targets, the representations and warranties of the seller do not survive the closing). Representations regarding a target company's net working capital are a common source of post-closing disputes.

Covenants, which govern the conduct of the parties, both before the closing (such as covenants that restrict the operations of the business between signing and closing) and after the closing (such as covenants regarding future income tax filings and tax liability or post-closing restrictions agreed to by the buyer and seller parties).

Termination rights, which may be triggered by a breach of contract, a failure to satisfy certain conditions or the passage of a certain period of time without consummating the transaction, and fees and damages payable in case of a termination for certain events (also known as breakup fees).
Provisions relating to obtaining required shareholder approvals under state law and related SEC filings required under federal law, if applicable, and terms related to the mechanics of the legal transactions to be consummated at closing (such as the determination and allocation of the purchase price and post-closing adjustments (such as adjustments after the final determination of working capital at closing or earnout payments payable to the sellers), repayment of outstanding debt, and the treatment of outstanding shares, options and other equity interests).

An indemnification provision , which provides that an indemnitor will indemnify, defend, and hold harmless the indemnitee(s) for losses incurred by the indemnitees as a result of the indemnitor's breach of its contractual obligations in the purchase agreement.

Post-closing adjustments may still occur to certain provisions of the purchase agreement, including the purchase price. These adjustments are subject to enforceability issues in certain situations.
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