Ebner Stolz


Pitfalls in corporate acquisitions

An­yone who spends a lot of mo­ney to ac­quire so­me­thing would su­rely like to know whe­ther what he’s buy­ing is what he thinks it is. Who wants to buy a pig in a poke?

Every in­ves­tor who’s got his eye on a com­pany would like to know what’s go­ing on be­hind the sce­nes, which is why he care­fully scans the com­pany’s busi­ness mo­del, fi­nan­cial state­ments, tax si­tua­tion and con­tracts. The past and the fu­ture are both on trial, and thus so are the fo­re­casts for the com­pany’s de­ve­lop­ment. One pro­ven way of ac­com­plis­hing this is by a due di­li­gence pro­cess. Due di­li­gence in­ves­ti­ga­ti­ons shine lights in dark cor­ners, make sure that ever­yone has ac­cess to the same in­for­ma­tion, and iden­tify and eva­luate risks in a sys­te­ma­tic fa­shion. Pro­perly pre­pa­ring due di­li­gence is half the battle – and that ap­plies equally to purchasers and sel­lers. There are four ty­pes of due di­li­gence: com­mer­cial, tax, le­gal and fi­nan­cial.

Commercial due diligence

Com­mer­cial due di­li­gence puts the stra­tegy and mar­ket po­si­tion of a com­pany to the test. It deals with the spe­ci­fic cir­cum­stan­ces of the mar­ket and com­pe­ti­tion: What are the com­pany’s strengths and weak­nes­ses, how is its mar­ke­ting stra­tegy working, what are the bar­riers to mar­ket entry, which busi­ness pro­ces­ses are va­lue dri­vers, which are cri­ti­cal for suc­cess? And above all: are the tar­get growth ra­tes and gross earnings ex­pec­ta­ti­ons rea­listic?

Tax due diligence

Tax due di­li­gence ana­ly­ses the com­pany’s tax si­tua­tion: have there been any es­sen­tial chan­ges in struc­ture? Are there hol­ding pe­riods that need to be ob­ser­ved? Are there any tax loss carry-for­wards that could be lost be­cause of the plan­ned tran­sac­tion? It also pro­vi­des a ba­sis for de­ci­ding how a pos­si­ble in­vest­ment can be op­ti­mi­zed for tax pur­po­ses.

Legal due diligence

Le­gal due di­li­gence is about con­tracts and agree­ments that are im­port­ant to the com­pany and ran­ges in scope from the eva­lua­tion of li­cense and supply agree­ments to the ana­ly­sis of lia­bi­lity and war­ranty risks. The main is­sues to be dealt with in the purchase agree­ment are also pre­pa­red du­ring the due di­li­gence phase.

Financial due diligence

Fi­nally, fi­nan­cial due di­li­gence deals with the com­pany’s fi­gu­res. Be­gin­ning with a so­lid ana­ly­sis of its past that ex­ami­nes such his­to­ri­cal fea­tures as its earning po­ten­tial, cash flow si­tua­tion, working ca­pi­tal de­ve­lop­ment, and ad­he­rence to bud­get, fi­nan­cial due di­li­gence scru­ti­ni­zes the com­pany’s cur­rent de­ve­lop­ment along with its plans for the next th­ree years. An ex­pert opi­nion will be gi­ven on the plau­si­bi­lity of the plan’s pre­mi­ses, the ma­nage­ment’s hand­ling of the plan, and rea­di­ness of the books to pro­vide the ne­cessary num­bers and facts for plan­ning.
Risk fac­tors in a due di­li­gence in­ves­ti­ga­tion
Es­pe­cially in the case of in­vest­ment pro­jects, fi­nan­cial due di­li­gence fo­cu­ses on the ques­tion of whe­ther busi­ness plan­ning seems rea­listic. The fol­lo­wing pit­falls have pro­ven to be the most com­mon in prac­tice.
Ho­ckey stick pro­jec­tions fo­re­cast dou­ble-di­git growth ra­tes for the fu­ture even though past growth ra­tes for both re­ve­nue and earnings have been mo­dest. In such ca­ses, the ma­nage­ment needs to be able to ex­plain what facts they’re ba­sing their high hopes on.
Ano­ther pos­si­ble pit­fall is the lack of a po­si­tive trend in the cur­rent fis­cal year. While a po­si­tive trend in or­der in­take or pro­duc­tivity in­di­ca­tes that the fol­lo­wing year could turn out just as well, the op­po­site trend or even a slump in es­sen­tial key fi­gu­res ser­ves as a clear warning si­gnal. Ma­nage­ment needs to be pre­pa­red to give so­lid coun­ter­ar­gu­ments.
It is also com­mon for fu­ture costs to be un­de­re­sti­ma­ted. In such ca­ses, it’s im­port­ant to come up with a plau­si­ble and de­tai­led cal­cu­la­tion. Ex­pan­ding into new mar­kets re­qui­res ca­pi­tal and time. Cre­di­ble busi­ness plan­ning needs to in­clude both start-up costs and lead ti­mes.
Fi­nally, cer­tain ne­cessary in­vest­ments are of­ten not (suf­fi­ci­ently) ta­ken into con­side­ra­tion: es­pe­cially the ac­qui­ring of new me­ans of pro­duc­tion crea­tes a sub­stan­tial need for fi­nan­cing. This needs to be re­flec­ted in ba­lance sheet and cash flow plan­ning.
The need for avail­able fi­nan­cial re­sour­ces should also not be un­de­re­sti­ma­ted. Ex­pan­ding a com­pany’s ope­ra­ti­ons usually leads to an in­crease in re­ceivab­les and in­ven­to­ries and ties up working ca­pi­tal – an area in which com­pa­nies of­ten plan too op­ti­misti­cally.
And last but not least, the qua­lity of fi­nan­cial ma­nage­ment and ac­coun­ting is im­port­ant: pro­fes­sio­nal re­por­ting that yields re­lia­ble fi­gu­res every quar­ter is not so­me­thing for me­dium-si­zed com­pa­nies to take for gran­ted. To­day’s fi­nan­cing banks tend to place hig­her de­mands on re­por­ting, and the ac­coun­ting of many mid-si­zed busi­nes­ses is not pre­pa­red to meet these de­mands. Many com­pa­nies do their own day-to-day book­kee­ping and leave the an­nual fi­nan­cial state­ments to their tax ad­vi­sors. It pays off here to get the books in or­der in ad­vance by brin­ging in ex­ter­nal con­sul­tants. Other­wise, due di­li­gence won’t be able to pro­vide in­ves­tors with a suf­fi­ci­ent ba­sis for ma­king a de­ci­sion, and it may also take some time af­ter a tran­sac­tion be­fore the in­ves­tor is able to im­ple­ment a func­tio­nal ac­coun­ting sys­tem again. Un­til that hap­pens, the com­pany will find its­elf fly­ing blind – so­me­ti­mes with fa­tal con­se­quen­ces.
In or­der to re­co­gnize and deal with these risks while con­duc­ting cor­po­rate tran­sac­tions, both buy­ers and sel­lers need an ex­pe­ri­en­ced ad­vi­sor by their side. We know the needs of in­ves­tors in mid­si­zed com­pa­nies and we de­ve­lop our ana­ly­sis and re­por­ting along those lines. In con­junc­tion with our cli­ents, we de­fine the scope of the in­ves­ti­ga­tion ac­cor­ding to the par­ti­cu­lar goals, oc­ca­si­ons, and si­tua­ti­ons that they are dea­ling with. The ap­proach of our tran­sac­tion spe­cia­lists can be de­scri­bed as hands-on, prag­ma­tic, and to the point.

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