Gareth Smyth: Buyer Beware Is The Bottom Line When Acquiring A Company

Gareth Smyth
Gareth Smyth

 

 

As Benjamin Franklin, one of the founding fathers of the United States of America, once famously said ‘failing to prepare is preparing to fail’.

 

While Benjamin Franklin died more than two hundred years ago, his words of wisdom still hold true for people from all walks of life.

 

However, to my mind, it should be a mantra particularly adopted by all those who run business because without a doubt proper planning is fundamental to success.

 

When it comes to buying a business, it is essential that precautions are taken to make sure you don’t buy a lemon because when a deal goes bad and collapses it can leave a very bitter taste.
It is a common misconception that the bulk of the hard work is over once you have pinpointed a company to buy that fits in with your business ambitions and dreams.

 

But this is far from the truth, as to ensure you don’t get caught out much further time, thought, effort, research, and organisation needs to be employed before a deal is agreed and all parties are ready to sign on the dotted line.

 

It is imperative that a perspective buyer and their business advisers carry out financial and legal due diligence, which is a comprehensive appraisal of a business to establish its assets and liabilities, evaluate its commercial potential and pinpoint any potential pitfalls.

 

Going into more detail what is the point of due diligence?
• To identify any areas of risk of which the buyer currently is unaware
• To confirm the reasonableness of the financial data provided by the seller
• To assist the buyer with assessing the correct price is being paid
• To pinpoint what warranties and indemnities may be required from the seller
• To assess the level of ongoing working capital (funding) required
• To allow the buyer to create post completion plans for management and strategy
• To test any ‘synergy’ benefits assumed by the buyer in respect of the acquisition
• To check for any inconsistencies in information

 

It is not only smaller concerns that can be caught out by not doing the requisite checks.

 

Indeed, computer giant HP had to drop the bombshell, when announcing its financial results for 2012, that it has lost $5bn when it bought software company Autonomy as there were inaccuracies in income statements, balance sheets and cash flow information.

 

The process of due diligence should include a detailed search of public information sources, meetings with the seller and their management team, access to financial records, audits, tax files and financial forecasts and a collation and analysis of all the attained information as a precursor to further questioning the seller and its executives if necessary.

 

It also should investigate other aspects of a target company such as the title to business assets, intellectual property rights, share capital and shareholders, legal compliance, contacts, pensions, tax and data, employees, legal compliance and data protection.

 

The compilation of all the information gleaned from this detailed trawl through a company’s set-up is pivotal to the purchaser’s business advisers being able to draft a comprehensive report on whether the deal is a sound one.

 

In addition, if the management team is to be retained its members should be stress-tested for their competency and suitability.

 

Also requiring scrutiny are any potential environment issues, operational characteristics, such as supply chain management, production processes and cost analysis, and the viability and constitution of the pension scheme.

 

Background Intelligence obtained during the due diligence process help both the buyer and the target company to draft appropriate merger and acquisition paperwork and other appropriate ancillary documents.

 

It also plays a vital in part negotiating the right value for both parties, based on the legal obligations of the target company.
Due diligence also can determine what a buyer may need to protect themselves in the form of warranties and indemnities required to ensure any statements or information upon which they have relied are contractually enforceable.

 

And last but not least, if due diligence throws up a catalogue of corporate horrors, a potential buyer will have sufficient information to justify walking away before any financial harm is done to them and their commercial interests.

 

By Gareth Smyth, CEO of Hilton Smythe Group

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