FINANCIAL DUE DILIGENCE

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Natalie Harper
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1 Page 1 FINANCIAL DUE DILIGENCE Bankers Manapakkam Study Circle Presenter : Bhama Krishnamoorthy Date 29 th August 2017 Time 5.00 pm to 7.00 pm

2 DUE DILIGENCE WHAT WHY Orderly investigation of complete 360 angle matters pertaining to business. Serves as a strong legal defense to third-party claims after a transaction closes. Reduce legal issues by alerting an investor to potential liabilities that can be mitigated prior to closing the transaction. HOW Simply doing your homework. Before putting funds, make yourself an expert and investigate to the minutest of details to avoid a bad investment. Page 2

3 AUDIT VS DUE DILIGENCE Pre Mortem DUE DILIGENCE Facilitation of financial decision making for investor Transaction focused & detailed TIMING PURPOSE REPORT Post Mortem AUDIT Statutory reporting & report to shareholders True & Fair view Industry standards & deal scope Controlled GOVERNACE ACCESS Companies Bill, A/c standards Full Page 3

4 TYPES OF DUE DILIGENCE Accounting Due Diligence: Financial Due Diligence: Tax Due Diligence: Legal Due Diligence: Financial & management accounts analysis Compliance with significant accounting policies & GAAP Trend analysis of revenue and cost Analysis of historical trend and Budgets/ forecasts Review of business plan Business valuation Deal financing for proposed Transaction Feasibility analysis and future prospects Quality assessment of FSLI s Current tax position analysis Tax impact assessment Historic tax exposure analysis Tax saving opportunities Identification of tax neutral deal structuring options. Assessment of On balance sheet and off balance sheet liabilities and potential risks Mechanics of the proposed transaction mechanics and execution. Analysis of historical and projec ted capex and liquidity ratios Page 4

5 FINANCIAL DUE DILIGENCE? WHAT Thorough deep dive analysis of the business plan and also historical financial numbers vs forecasts for making a decision on a particular transaction. WHY Avoid unpleasant business performances after acquisition and also to safeguard from any future legal battles. Understand the true value of the assets and liabilities and find any discrepancies or deliberate book building. Benefits in negotiation as it helps facilitating better deal terms Page 5

6 OBJECTIVES OF FINANCIAL DUE DILIGENCE Investigation of business affairs Verify that the transaction complies with investment or acquisition criteria. Risk Management Opportunity cost assessment of a proposed transaction Reduction of post-transaction unpleasant surprises Enabler in negotiation and creation of trust between two unrelated parties Facilitation of decision making Page 6

7 MERGERS & ACQUISITIONS AND DUE DILIGENCE Using different methods, the investor team tries to find an answer to the question : Do we or do we not? To answer this question, the team targets predominantly 4 areas which are: Business performance Historic and future Authenticity of Financial data True worth of current and capital assets and the lien thereon Contingent liabilities & Commitments and guarantees given Outstanding and potential litigations Nowadays, firms develop in-house due diligence expertise for Maintaining internal controls. Detect any deliberate or erroneous business/ financial activity. Put forward a good defense in case of any potential M&A deal. Page 7

8 MERGERS & ACQUISITIONS AND DUE DILIGENCE Key items to check during due diligence for Mergers & Acquisitions (M&A) Trend analysis of company s financial position for last 3 years Is there an independent audit of the company s financial position? Do the FS depict all the current and contingent liabilities? Is the business booming or deteriorating? Assessment of the authenticity of the operating and capital budgets. Historic performance vs Forecast comparison and analysis What is the normal liquidity requirement for future continued performance? What are the current capital commitments and what capex is required for growing business? Condition of assets and liens thereon. Is the depreciation on the capital assets provided for correctly? Aging of the accounts receivable and potential bad debts discovery Is the EBIDTA and any adjustments properly accounted? Page 8

9 Scope and timelines agreement with client PROCESS PRE Analysis of preliminary information like MoA, incorporation certificates, ownership structure etc. Understand the micro and macro elements affecting the business of the potential investment Industry research Assessment of the historic business performance and its authenticity Co-relate the forecasts with the historic performance and market information Liaison with management to validate findings Page 9

10 PROCESS POST Discussion with client about key findings and future implications Issuance of final report Structure of final report Executive Summary: Draws investor s attention Key positives and negatives Main Body: Work done and inferences Appendices: Detailed documentation for the work done. Page 10

11 CASE STUDY Page 11

COMMON ISSUES SEEN Application of Accounting Standards Eg 1 : Company recognizes income on cash basis instead of accrual Eg 2 : Difference in AS as applicable for investor vs target company

12 COMMON ISSUES SEEN Application of Accounting Standards Eg 1 : Company recognizes income on cash basis instead of accrual Eg 2 : Difference in AS as applicable for investor vs target company Contingent Liabilities Eg 1 : Insufficient payment of employee insurance/ social security contribution Eg 2 : Possible litigation risks due to breach of laws relating to target company Related party transactions Eg 1 : Providing off balance sheet guarantees to its affiliated firms for the interests of the company rather than for its business objectives Income Tax According to over-statement/ under-statement of profit, the income tax payments needs to be accordingly revisited. Page 12

DUE DILIGENCE DISASTERS CORPORATES YEAR & VALUE

create automotive giant Competitive analysis

1B HP to move from computer hardware to software

7B 1994-800M Quaker wanted to enjoy similar

diversification & increase sales Intellectual

13 DUE DILIGENCE DISASTERS CORPORATES YEAR & VALUE GOAL OVERSIGHT LOSS $40B Join forces & create automotive giant Competitive analysis $34B $11.1B HP to move from computer hardware to software Inaccurate FS & cash flow analysis $5B $1.7B M Quaker wanted to enjoy similar success of acquisition of Gatorade BMW intended diversification & increase sales Intellectual property & competitive analysis Inaccurate info on sales & cultural clash $1.4B 790M Page 13

DUE DILIGENCE SUCCESSES CORPORATES YEAR & VALUE GOAL IMPACT 2006

graphics Technology Create world s biggest oil company & cost

to eliminate duplicated program costs Successful movies - Toy

5B Remains strongest leader in oil market.

earnings Q4 2009 reported profit for first time, has 30m

14 DUE DILIGENCE SUCCESSES CORPORATES YEAR & VALUE GOAL IMPACT $7.4B $81B $13B Acquiring Pixar s computer graphics Technology Create world s biggest oil company & cost Rationalization Pre merger, neither had an annual profit, goal to eliminate duplicated program costs Successful movies - Toy Story3, Up, Wall E, Ratatouille whose combined revenue is $3.5B Remains strongest leader in oil market. In 2008, bagged all 10 spots in Top 10 Corporate Quarterly earnings Q reported profit for first time, has 30m subscribers as on Q1 16 and has/ had celebrity Shows hosted by Jim Parsons, Oprah Winfrey, Martha Stewart Page 14

15 On a lighter note. (Joke, Joke!) Page 15

16 THANK YOU! Page 16

Risk Management: Assessing and Controlling Risk

Risk Management: Assessing and Controlling Risk Introduction Competitive Disadvantage To keep up with the competition, organizations must design and create a safe environment in which business processes