My time in M&A due diligence at my firm is an area I get a million questions about. I recently wrote this post about how I was able to transfer into the M&A due diligence practice within my Big Four firm. However, this post is going to be dedicated to what to expect once you actually join the group.
The first thing to understand is the high-level deliverable. Why do companies hire firms to perform due diligence?
If a company is on the buy-side and looking to purchase another company, before they actually buy it they want to understand (1) if there are any potential deal breakers that might make them want to back out and (2) if the sellers’ financial performance that the purchase price is based on is really what they claim it is.
There are also times where due diligence firms are engaged on the sell-side. Someone may want to sell their company but they don’t have the manpower or skills to pull together all of the financial information in a good format. The diligence firm will compile the financial information and will help them identify any management adjustments that will improve their sell-side process and potentially the purchase price.
By engaging an M&A due diligence firm, it provides both parties with an independent analysis of the financials of the sellers.
What is the typical buy-side engagement like?
Most of my engagements were on the buy-side. These typically would last 3-4 weeks from start to finish. Here is a timeline of what to expect:
- Engagement letter signed
- Create a data request list (“DRL”) for items you need for the analysis
- Waiting period for dataroom to open (usually can count on it opening on Friday at 4pm)
- Dataroom opens – begin downloading all files and go through them
- Prepare databook – always start out with a tab with a monthly income statement and balance sheet. From there you can build additional tabs for EBITDA, NWC, and Net Debt tables that link to the supporting trial balances. Additional tabs may be added where needed, such as AR Aging, etc. Highlight/add comments for any weird trends or fluctuations.
- Audit Workpaper Review – this can happen either before or after the management meeting, depending on the timeline available. This usually last 1-2 days where you will travel to the auditors (if they company was audited) and review their prior year workpapers. You can’t take them with you so it’s a big day of typing and writing notes. Big areas you want to look for: audit adjustments, control deficiencies, risk areas, legal fees, AR reserves, and other highly judgmental areas that might be prone to errors.
- Prepare Agenda/Exhibits for Management Meeting – Based on your trend analysis that you performed in the databook, it may lead to some further questions that you need to ask the company about.
- Attend Management Meeting – There is usually a full-day on site meeting with the target and you can go through all of the questions. This meeting is usually led by Senior Manager with Partner chiming in. The lower levels take very thorough notes during this meeting. It’s a good idea to write down literally everything, because you never know what kind of issues you will identify from this meeting.
- Finalize Databook with Adjustments Identified – based on your management meeting you will be able to identify certain non-recurring items, out of period adjustments, or errors that should be adjusted for in EBITDA / NWC tables. On those tabs, you will have rows to fill in these adjustments, which will lead to a final “Diligence Adjusted EBITDA” row and a “Diligence Adjusted NWC” row.
- Prepare Report – Once the databook is completed and the EBITDA/NWC/Net Debt tables are finalized it’s time to put that into a report form, which is the final deliverable for the client. Your firm will have a standard template that should be followed, and now it’s just a practice of pasting in the tables you made from the databook and adding in commentary.
- Report Walk Through – After the report has been finalized/reviewed by Partner and EQCR, it’s sent to the client. There is also a call set up to walk the client through our findings, which is usually led by the Senior Manager. This is the final deliverable, although sometimes the client will request that we look at something additional or potentially do a “report refresh” later on, which basically just means updating our analysis through a later date once that financial information becomes available.
The sell-side is a very similar process, but the client is different so it’s more of a partnership working with the client to prepare the sell-side report and how they want the financials presented. It’s a longer process since the client is going through bids and may have to present this report to several different buyers, who also engaged their own diligence teams.
Another engagement you might end up on is a carve-out. These tend to last a long time. I was on a carve-out project that latest about 8 months and required travel to the client every week. It basically involved taking the companies financial information and separating it out by the product that they were looking to divest. It was a great learning experience but these projects can last a long time, so be weary of joining a deal like this if it’s not in a great location or if you don’t want to travel every week.
What’s the best way to prepare for your upcoming role in due diligence?
Assuming you have a solid accounting background you will be just fine. However, if you really want to do something to prepare I would suggest researching examples of diligence EBITDA and NWC adjustments. This will give you an idea of what types of things to be looking for. Common EBITDA adjustment examples: bonus normalization, one-time restructuring expense addback, executive compensation normalization to market cost, cash to accrual adjustments, proposed audit adjustments that weren’t made, etc.
You might feel overwhelmed at first, I know I was. I had no idea what to expect for my first deals. The good news is there will always be examples available. If you need an example DRL, databook, management meeting agenda, or report, someone will definitely share. It’s all about asking around and after 2-3 deals you will feel like an expert!
Lets Get Fiscal