I realized about a year ago that Financial Due Diligence in M&A was an obscure notion for a lot of people, including entrepreneurs and people working in corporate finance. 

Yet, most of the skills that are the most useful to me when it comes to reviewing Private Equity investment opportunities, doing fundamental analysis of a publicly listed stock or managing an M&A process, I acquired doing Financial Due Diligence. 

That is why I decided to help people interested or engaged in a career in corporate finance and finance analysis by making the tools and techniques used in Financial Due Diligence accessible and easily understandable. 

To do that I’ve put together a full step by step online Financial Due Diligence course that builds on years of hands-on experience to provide a clear framework on how to review the financial statements of a company to spot red flags and drive insights. 

So for anyone out there wondering what Financial Due Diligence really are, curious enough to learn more and eager to step up your game and skills in financial analysis, here is a checklist and breakdown:

Overview of What is Financial Due Diligence In M&A

In most cases, due diligence is required in the context of any event where an important new stakeholder is considering being financially involved with a new Target company. 

More specifically, due diligence experts will be needed in the following contexts:

  • A capital raise involving private equity investors
  • A transfer of ownership of part or all of a company’s equity (e.g. an acquisition)
  • A merger between two strategic players on a given market
  • An IPO (initial public offering), i.e. a private company becoming public
  • A public-to-private transaction (e.g. a listed company acquired by a privately own company)
  • A debt financing event

What Is The Purpose of Due Diligence?

Due diligence is meant to provide buyer / investor with a clear and comprehensive understanding of the Target business and to spot any potential red flags that may endanger the perennity of the company post-acquisition. 

There are several types of due diligence:

  • Financial Due Diligence (FDD)
  • Commercial (ie analysis of the market)
  • Tax (ie. assessing risk around tax structure and if a company is not at risk of unpaid tax litigation)
  • Legal (ie. do contracts abide by the law, are there any ongoing litigation etc)
  • Operational (which are there to get comfort about the efficacy of the target’s operations, identify any risk and assess how scalable the business operations are. ODD will also assess potential synergies in the case of a strategic acquisition, or additional needs for a carve-out business. ODD will focus on supply chain, engineering, manufacturing operations etc. They’re here to assess whether the business can deliver on their business plan)
  • IT (is the whole IT infrastructure solid, is the code reliable, well organized and well documented etc.)

In short, due diligence is there to do an in-depth assessment of a specific aspect of a company. In my career I have specifically developed an expertise in Financial Due Diligence in M&A (FDD) and will be focusing on FDD for the rest of this post.

What Are The Main Objectives of Financial Due Diligence in M&A?

If I were to summarize the main goals of a Financial Due Diligence in M&A over three main points, it would have to be :

  1. Provide a clear and deep understanding of the revenue generation and profitability structure of the Target
  2. Provide a normalized view of financial indicators and aggregate impacting deal value (EBITDA, Net Debt, Cash Flow, Net Working Capital etc.)
  3. Use a fact-based approach of historical performance to assess the feasibility of forecast. 

What is also important to highlight to better understand the context of a Financial Due Diligence work is that, as an M&A consultant, a FDD is meant to be an independent review of a Target’s financials.

What Are The Big Types of Projects of a Financial Due Diligence M&A Team?

There are 3 major types of projects a Financial Due Diligence team will be working on in major M&A firms providing Transaction Services

1. The Vendor Due Diligence (VDD)

The client is the Seller / Target company.

They ask the FDD team to do a comprehensive and independent review of their financials and of their business. This generally helps the seller be better prepared for a deal by uncovering potential issues early in the process. 

When multiple bidders are involved in the process, it also allows Target’s management to save a lot of time by providing every bidder with a comprehensive analysis of their business and avoid them to answer the same questions over and over again.

VDD usually last longer than buy-side engagements and access to information is easier for the FDD team since the Financial Due Diligence team is working hands in hands with the Seller’s team.

However please note that sometimes there may be some internal conflicts with some of the Top Management who may be unhappy with the sale of the business and which may create obstacles to the work of the Financial Due Diligence team.

2. The Buy-Side Due Diligence

The client is the buyer / investor.

Generally, in buy-side, access to information may be more limited than if you are performing a Vendor Due Diligence, and your report will generally be less exhaustive than a VDD because your client may have a specific scope of work in mind, in other words certain areas of the business they specifically want to get comfort about. 

It is also common, especially for large size deals, that a buy-side due diligence be mostly done on the basis of the VDD. The role of the Financial Due Diligence team is then to challenge the findings presented in the VDD and potentially derive additional analyses to uncover new findings.

I think it is important to note here that yes, in theory due diligence reports are an independent review of a Target and there should not be difference between findings and conclusions in a buy-side and a sell-side report.

The reality is that there are several items where the FDD team can decide to take a more or less aggressive view (on Quality of Earnings (i.e. EBITDA adjustments) for instance). Also, a client may push for some analyses to be removed or amended. 

Overall, the FDD team may agree on a few tweaks to make their client happy but won’t budge on the key messages and analysis. Their reputation is on the line, and this is generally their most valuable asset!

3. The Vendor Assistance

The Vendor assistance is less “formal” than a VDD or a Buy-Side report. The goal here is not to provide a view, but to help the seller prepare for a Transaction by helping them clean their data. In a vendor assistance engagement, the FDD team can also help with preparing stand-alone financials in the case of a carve-out for instance.

In the case of a Vendor Assistance, the Financial Due Diligence team basically helps their client prepare the data that will be used by the buy-side due diligence team. In a sense, a VA is a lighter version of a VDD and as such does not need to be as exhaustive.

What Is Included In A Financial Due Diligence Report?

The report will obviously be read by the potential buyer, but it may be shared to other parties. Here is a quick overview of who can use a Financial Due Diligence report and how they would use it.

  • Buyer, to prepare their own forecast and refine their valuation of a Target company.
  • Board of directors to agree on the details of a Transaction 
  • Banks, to agree on a certain amount of financing
  • A Financial Due Diligence report prepared by a renowned and respected firm may also weight in the negotiations by providing an expert eye on technical points and providing and independent review of a normalized EBITDA
  • Also, the reality of the market is that having one of the big 4 sign-off on a Financial Due Diligence report and showing that no substantial risk has been found is a way for decision makers to give away the responsibility if anything negative is uncovered Post-Transaction. 

In Summary

If you’re interested to learn more on how to review the financial statements of a company to spot red flags and drive insights check out Horizen Capital’s Financial Due Diligence course that’s built on years of hands-on experience to provide a clearer framework and help you land your dream job in transaction services.

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