When hiring a financial professional for due diligence, especially in the context of a business acquisition, it’s easy to assume that providing some initial details will yield exactly what you need. Imagine expecting a quick summary of key financial metrics but instead receiving a dense, GAAP-compliant report filled with technical jargon. This common scenario highlights the importance of setting clear expectations from the start.
Due diligence plays a critical role in mergers and acquisitions (M&A), helping you uncover financial risks and assess a business’s true value. To ensure the process works for you, follow these best practices.
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Be Clear About What You Need
Before the engagement begins, take time to define what you want from the M&A due diligence process. Consider asking yourself questions like:
- Are you looking for a high-level financial overview or detailed GAAP-compliant analysis?
- Do you need numbers simplified for quick decision-making or more comprehensive financial models?
Checklist for Outlining Your Needs:
- Type of Analysis: High-level overview vs. detailed GAAP-compliant review
- Financial Focus Areas: Cash flow, working capital, revenue recognition, expense normalization
- Presentation Format: Simplified executive summary vs. detailed financial report
- Use Case: Decision-making, investor reporting, lender presentations
- Report Deadline: Expected due diligence timeline and project milestones
Pro Tip: Clearly communicate the purpose of the financial report. For example, “We need a simplified view of the company’s cash flow for decision-making purposes” vs. “We need a GAAP-compliant report for lenders and investors.” Consider using this checklist to organize and prioritize your specific needs.
Communicate Your Ideal Outcome
Service providers often interpret your requests based on their expertise, which might be more technical than you expect. Be specific about the outcome you’re looking for. Try framing your request like this:
- “By the end of this engagement, I want to understand the business’s cash flow in simple terms.”
- “Help me calculate a reasonable offer price by identifying key adjustments to EBITDA.”
The more precise your goals, the more likely you’ll receive actionable insights.
Request a Detailed Project Plan
Ask your service provider to outline their process, deliverables, and timelines upfront. This allows you to spot potential misalignments early. A strong project plan should include:
- Deliverables: Specific reports, summaries, models, and presentations.
- Timelines: Clear milestones with estimated completion dates.
- Areas of Focus: Key areas like working capital adjustments, revenue recognition, and expense normalization.
Pro Tip: Request regular progress updates to ensure the project stays on track.
Don’t Be Afraid to Ask for Simplicity
Financial professionals may default to presenting data in detailed, technical formats. If you’re not familiar with GAAP or technical financial jargon, ask for simplified explanations:
- “Can you break this down in plain language?”
- “What does this mean for the business’s future profitability and cash flow?”
Consider requesting a summary section in the report highlighting the most critical takeaways, supported by detailed data in appendices. For example, if a technical term like “normalized EBITDA” comes up, ask for a straightforward explanation, such as:
- Normalized EBITDA: This term adjusts earnings by removing irregular or non-recurring expenses to give a clearer picture of ongoing profitability. In simpler terms, it helps you see what the company’s true earnings potential might be under normal circumstances.
Course-Correct if Needed
If the deliverables are more complex or different from what you expected, speak up as soon as possible. Service providers want to deliver value, and early feedback allows them to adjust their approach.
Example: During one engagement, a client received a highly technical cash flow projection that felt overwhelming. After providing immediate feedback, the service provider restructured the report into a one-page summary with key bullet points, making it easier to understand while keeping the detailed data as an appendix. This adjustment helped the client make faster, better-informed decisions.
Recognize the Limits of the Engagement
Remember that financial professionals work within the scope defined at the beginning of the project. If additional areas of analysis emerge, expect that these may require an expanded scope or a follow-up engagement.
Pro Tip: Clarify early on whether follow-up questions or adjustments after delivery are included in the engagement fee.
Be Ready to Collaborate
Financial due diligence is not a one-way street. Be prepared to provide necessary documents, answer questions, and clarify business-specific nuances as needed. Collaboration ensures that the final analysis is both accurate and actionable.
Manage Expectations for Final Deliverables
Due diligence reports are designed to highlight potential risks, validate key financial metrics, and offer recommendations. They won’t “solve” business issues but will give you the data needed to make informed decisions. Approach the report as a decision-making tool, not a guaranteed blueprint for success.
What Happens If Something Negative Is Found?
Discovering negative findings during due diligence can be concerning, but it’s a critical part of the process. Here’s how such situations are typically handled:
- Early Discovery and Decision to Stop
If significant red flags in due diligence are identified early, you may choose to terminate the process before further costs accumulate. This can include findings like:
- Major revenue inconsistencies
- Legal disputes or compliance issues
- Significant operational weaknesses
How Fees Are Handled:
- Predefined Terms: Many engagements have clear termination clauses outlined in the service agreement.
- Partial Fees: You may be responsible for fees related to work already completed.
- Negotiation Option: In some cases, providers may be open to renegotiating the fee structure if termination occurs early.
- Proceeding Despite Negative Findings
Sometimes, negative findings don’t end the process but inform your negotiation strategy. Consider these next steps:
- Price Adjustments: Use findings to negotiate a lower purchase price.
- Contract Revisions: Request additional warranties, guarantees, or escrow arrangements.
- Walk Away: Consider stepping away if risks outweigh potential benefits.
Conclusion
Financial due diligence is a collaborative process. By clearly communicating your goals, asking the right questions, and staying engaged, you can ensure your report meets your needs.
FAQ
Frequently Asked Questions
Be specific about the type of analysis you need. Use a checklist that includes report format, key financial focus areas like cash flow and working capital, and expected timelines.
Clearly state what you hope to gain, such as simplified cash flow projections or adjusted EBITDA calculations. This ensures your service provider focuses on your priorities.
Your service provider should outline deliverables, timelines, and major areas of focus like working capital adjustments, revenue recognition, and financial modeling.
Ask for summaries that explain terms like “normalized EBITDA” in plain language. Request executive summaries backed by detailed data in appendices.
Provide immediate feedback and request changes. Service providers often adjust their approach if expectations were misunderstood.
If red flags are found early, the engagement can be terminated. Many agreements include partial fee terms based on work completed up to that point. For more insights, check out our guide on M&A fees by deal size.
Be responsive, provide requested documents promptly, and clarify operational and financial nuances as needed to keep the process on track.
If serious issues arise, you can renegotiate the purchase price, adjust deal terms, or walk away if risks outweigh the benefits.
A comprehensive report should cover financial performance, operational risks, legal compliance, and recommended action steps based on findings.
Organize relevant financial records, update tax filings, and set clear communication expectations with your service provider for a smooth process.
