{"id":923,"date":"2019-01-23T20:50:59","date_gmt":"2019-01-23T20:50:59","guid":{"rendered":"https:\/\/www.excelsisaccounting.com\/blog\/?p=923"},"modified":"2019-01-23T20:51:00","modified_gmt":"2019-01-23T20:51:00","slug":"ma-due-diligence-dont-accept-financial-statements-at-face-value","status":"publish","type":"post","link":"https:\/\/www.excelsisaccounting.com\/blog\/index.php\/2019\/01\/23\/ma-due-diligence-dont-accept-financial-statements-at-face-value\/","title":{"rendered":"M&A due diligence: Don\u2019t accept financial statements at face value"},"content":{"rendered":"

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Reviewing historical performance<\/strong> <\/p>\n

For starters, the target company\u2019s historical financial statements must be reviewed. This will help you understand the nature of the company\u2019s operations and the types of assets it owns \u2014 and the liabilities it owes. <\/p>\n

When reviewing historical results, it\u2019s important to evaluate a full business cycle, including any cyclical peaks and troughs. If a seller provides statements during only peak years, there\u2019s a risk that you could overpay.<\/p>\n

Historical financial statements also may be used to determine how much to offer the seller. An offer should be based on how much return the business interest is expected to generate. An accounting expert can project expected returns, as well as provide pricing multiples based on real-world comparable transactions.<\/p>\n

Evaluating the target\u2019s historical balance sheet also may help you decide whether to structure the deal as a stock purchase (where all assets and liabilities transfer from the seller to the buyer) or as an asset purchase (where the buyer cherry-picks specific assets and liabilities). <\/p>\n

Looking to the future<\/strong><\/p>\n

Prospective financial statements are typically based on management\u2019s expectations for the future. When reviewing these reports, the underlying assumptions must be critically evaluated, especially for start-ups and other businesses where prospective financials serve as the primary basis for your offer price.<\/p>\n

It\u2019s also important to consider who prepared the prospective financials. If forecasts or projections are prepared by an outside accountant, do the reports follow the AICPA standards? You may have more confidence when reports provided by the seller conform to these standards. However, it\u2019s a good idea to hire your own expert to perform an independent analysis, because management may have an incentive to paint a rosy picture of financial performance. <\/p>\n

Digging deeper<\/strong><\/p>\n

A target company\u2019s historical balance sheet tells you about the company\u2019s tangible assets, acquired intangibles and debts. But some liabilities may not appear on the financial statements. An accounting expert can help you identify unrecorded liabilities, such as:<\/p>\n

\u2022 Pending lawsuits and regulatory audits, \u2022 Warranty and insurance claims, \u2022 Uncollectible accounts receivable, and\u2022 Underfunded pensions.
You also need to be skeptical of representations the seller makes to seal a deal. Misrepresentations that are found after closing can lead to expensive legal battles. An earnout provision or escrow account can be used to reduce the risk that the deal won\u2019t pan out as the seller claimed it would.<\/p>\n

Avoiding M&A mishaps<\/strong><\/p>\n

Do-it-yourself acquisitions can lead to costly mistakes. In addition to evaluating historical and prospective financial statements, we can help identify potential hidden liabilities and misrepresentations, as well as prepare independent forecasts and projections. We also can help you determine the optimal offer price and deal terms based on an objective review of the target\u2019s historical, prospective and unreported financial information. <\/p>\n

\u00a9 2019
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