Finance is arguably the most critical part of the due diligence process. Almost every transaction comes down to the numbers unless it's a pure IP deal. Conducting effective financial diligence in M&A is crucial to every acquisition's success. This article tackles the basics of financial diligence featuring Amr Abdelaziz, Senior Director, M&A Finance at Equinix.
"Financial Due Diligence is about unpacking the company, understanding what's inside before closing the deal to avoid surprises and liabilities." - Amr Abdelaziz
The finance team leads the due diligence process and must be involved as soon as the acquirer gains access to the data room. Red flags are vital in negotiations, so they must be discovered early.
The first step to financial due diligence is to look at the target's historical financial information. The business's past performance is essential when evaluating its overall value. Using the target's income statement, it is turned into a quality of earnings (QofE).
A QofE is a financial report that removes all one-time events from the income statement to identify the normalized earnings of the business. It is currently considered a standard practice that both parties conduct their QofEs as it will be the primary basis of the valuation.
The next step is to look at the target's projected financial information. It is crucial to understand how the business plans to expand, which product lines they intend to invest in, and into which markets they want to expand. However, the acquirer must also come up with their financial projections. They can't just rely on the seller's projection as they are usually too optimistic and unrealistic.
After finding issues in the diligence process, the finance team must collaborate with the other internal teams, such as the legal and HR teams. Every discovery implicates other functions, so having a weekly deal team meeting is essential. Be transparent and discuss everything with everyone.
The finance team must also communicate with the target company to find resolutions. Amr likes to create a list where he can park all the problems encountered and mitigate them later. The goal during negotiations is to find a middle ground where both parties are happy taking on risks.
The finance team's work isn't done even after the deal is closed, and they must do the purchase price allocation and check for annual impairments of the newly acquired company's assets. Doing impairments is not a choice; it is an SEC rule that public companies have to follow to avoid driving stock prices down.