Due diligence in a recession

Carrying out due diligence before deal completion is prudent for all business purchases at any time. In an economic downturn, however, performing due diligence is absolutely crucial.

With many solvent companies affected to a varying degree by falling customer numbers, hiked energy costs and loss of contracts in the recession, it is essential for buyers to get a full, clear picture of the firm they have their sights on before completing the deal.

There will always be an element of risk in purchasing a business, but thorough due diligence undertaken before completion can flag up anomalies that could potentially turn into big problems later on.

Due diligence begins once the price and terms have been agreed between the business seller and buyer. Whilst the due diligence is taking place, the deal itself won’t be finalised. The seller can, however, take the business off the market during this phase, which can often take around a month for medium-sized businesses.

A company’s finances and legal position will be delved into as part of the due diligence – the nuts and bolts of any business, and should be examined carefully. An accountant will investigate cash flow, asset values, past financial records and statements, as well as future projections.

Legal due diligence is concerned with any documents relating to the physical property such as the mortgage, deeds and leases, as well as evidence of ownership of intellectual property.

The importance of due diligence was brought home by the government in a new ruling - the UK Bribery Act - which came into force on 1 July 2011 to tighten up the criminal law of bribery in Britain. Among other things, it calls for business buyers to increase their due diligence on purchases to avoid liability for any corrupt practices. Buyers should find out whether a company has complied with the ruling as part of the due diligence process. Any corrupt practices underlying a company’s current or future financial activities will be uncovered at this stage.

Despite these legal changes, findings from Ernst & Young’s 2012 Global Fraud Survey, Growing Beyond: A Place for Integrity carried out this year revealed that about one in five UK businesses fail to ‘frequently’ conduct pre-completion due diligence in regards to issues such as bribery, fraud and corruption.

It also found that many of the businesses questioned actually conduct their due diligence after the deal has gone through, not before.

The report stressed that it is crucial that anti-bribery and corruption due diligence commences straight away after the heads of agreement has been signed.

The earlier issues are identified, the sooner the buyer can grasp the financial and operational implications of a deal, examine any queries with a regulator or even back away if necessary.

The due diligence process also examines crucial basic information that could otherwise be easily missed when buying a solvent business. Asking if the business is really for sale may appear a simple question, but it can come to light that the buyer is merely looking into what interest can be generated and has no intention of actually completing. Finding out if all of the owners are agreed on the sale is another obvious question that should be asked early on to prevent wasting everybody’s time should there not be agreement.

So who carries out the due diligence? With small firms it is fairly common for the owners to take on the bulk of this task themselves, as they are likely to have the relevant experience and knowledge already. It is usual for larger companies, however, to have lawyers, specialist consultants and accountants on hand to contribute towards the whole process.

Regardless it is the buyer’s responsibility to ensure that whoever conducts due diligence has relevant business purchase experience and can address any special requirements relating to the industry concerned.

Fast growing telecoms firm Daisy went so far as installing its own due diligence team to assist in a string of acquisitions. Steve Smith, its director of M&A, brought two ex-Ernst & Young colleagues with him into the firm after he joined.

The Lancashire-based firm has made over 20 acquisitions in the past few years, and has enjoyed rapid growth as a result. It is to pay its first dividend next year after reporting a 30 per cent increase on revenues to £349 million.

A plethora of businesses are falling into administration every month in this recession, and canny buyers are spotting plenty of opportunities to snap up.

Such deals are highly competitive and will be on the market for a very short time. Timing is of the essence once a decision has been made to pursue a distressed business opportunity. Eager buyers may regard due diligence as a long drawn out, unnecessary procedure. However it can be used to purely focus in on problematic issues.

In fact there is a growing tendency for buyers to be far more focused on what they are looking for in a takeover and will pull out immediately if they aren’t comfortable with any aspect of the deal.

As Steven Ivermee, head of transaction support at Ernst & Young says, “Today we are seeing a much more issue- led approach to commissioning due diligence; it’s all more focused.”

“The first conversation will be about what the key issues that drive deal value are and what the investment criteria are against which we are judging the quality of the assets.”

Due diligence will determine what, if any, issues need to be addressed, what it will take to fix them in terms of resources, and of course if the company being examined is the right fit for the acquirer.

While a tendency to skip due diligence may reflect a rising pressure for business transactions to go through quickly in an uncertain, changeable. A plethora of businesses are falling into administration every month in this recession, and canny buyers are spotting plenty of opportunities to snap up. market, it is a crucial process for buyers to find out what they are getting themselves into before signing off the deal, and to avoid any problems later on.

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