In a complex and dynamic economic environment, holistic Financial Due Diligence (FDD) is important for the success of any transaction. In some cases, a great deal of effort is put into comprehensive checklists that create little added value and cloud the initially positive and entrepreneurial mood in a transaction. IFBC's ambition is to provide investors and lenders with a well-founded basis for decision-making with specific and clear FDD reports.
Key Takeways
Protect the deal: avoid bureaucratic duplication of effort and don't lose sight of the opportunities
Understand in detail how revenue is generated and where money is earned
Analyze the growth potential of the target company and the structure of the net working capital
Use the information gained to negotiate the purchase price and contracts
The following success factors are based on our many years of experience and allow us to focus on quality from the buyer's perspective in an FDD:
Protect the deal: Positive collaboration Target-oriented Financial Due Diligence increases transaction security and accelerates the process by limiting itself to analyzing key value drivers and maintaining the momentum of the transaction process. The focus on defined financial topics enables an efficient use of resources in the transaction process and strengthens trust between the transaction parties.
Example: A consumer goods company wanted to acquire an ambitious start-up in the field of sustainable packaging. The FDD deliberately concentrated on the key value drivers such as analyzing production costs and the scalability of production. By focusing on success-critical factors and the resulting constructive dialog with the seller, the transaction dynamics were maintained during the FDD process and the negotiations were concluded efficiently and successfully.
Check historical results: Quality of earnings A careful analysis of historical earnings (quality of earnings) reveals the financial quality of the company and strengthens the buyer's confidence in the earning power. The identification of extraordinary, non-recurring income and the elimination of non-cash and/or risky items enables a reliable assessment of the sustainable free cash flow that can be achieved.
Example: A private equity company examined the purchase of a fast-growing technology company that offers software solutions for the healthcare sector. When analyzing the historical financial figures, it was determined that a significant portion of the profit came from the sale of patents. These extraordinary profits are eliminated in order to determine the company's actual earning power from software subscriptions and services. The findings were used to check the plausibility of the business plan and as a basis for determining the purchase price.
Analyzing the business: Understanding the value drivers Understanding the business model and the value drivers of the target company makes it possible to focus on the key aspects of the balance sheet and earnings analyses in the FDD. With the sector knowledge of the due diligence service provider, the business plan can be critically reviewed and the risks and opportunities of the target company can be assessed in a well-founded manner. This allows the scalability and sustainability of the business model to be evaluated, the appropriateness of the assumptions to be checked and the most important factors and challenges of the growth strategy to be identified. Example: The FDD for a construction company with project business and a real estate developer clearly shows the different focus. In the case of the construction company, the focus of the FDD is on the evaluation of work in progress and the project pipeline, as the degree of completion and cost control are decisive for future profitability. In the case of the real estate developer, the focus of the FDD is on analyzing project financing and market demand in order to assess the profitability and risk of planned construction projects. The industry-specific FDD approach enables a valuation and risk assessment that takes into account the circumstances of the different business models.
Looking realistically into the future: Unlocking growth potential A well-founded analysis of the relevant markets and growth forecasts of the target company is often essential. The findings of the commercial, operational and financial due diligence form a central basis for validating the business plan and for valuing the target company. The plausibility of the forecasts is supplemented by assessing the impact of a change in the most important value drivers with the help of sensitivity analyses.
Example: An energy company plans to invest in the fast-growing market for hydrogen technology. The due diligence analyzes the market trends, such as increasing government support for renewable energy, and assesses the growth forecasts for the target company. An integrated due diligence approach consisting of commercial and financial due diligence and valuation makes it easier to assess whether the planned sales targets and margins are realistic, what risks they are subject to and whether the investment pays off from an overall economic perspective.
Check net working capital and debt-like items: Confidence in financial stability The analysis of net working capital (NWC) and debt-like items helps to understand the financial stability of the company and assess its ability to meet its financial obligations. The analysis of the historical development and development trends of the NWC enables the assessment of management assumptions and helps to identify optimization opportunities.
Example: During the audit of a leading electronics manufacturer, it was found that inventory levels were excessively high, indicating inefficient inventory management processes and inadequate demand forecasting. In addition, significant unrecognized warranty obligations were identified. The analysis enabled the buyer to gain an accurate overview of the short-term liquidity requirements and long-term financial obligations. A purchase price reduction was negotiated to compensate for the identified financial risks.
Implement FDD-findings: Adjustment of valuation and negotiation The results of the FDD provide important information for the valuation, the design of the transaction structure and the purchase price negotiation. A seamless flow of information between due diligence, valuation and negotiation team ensures consistent transaction decisions and helps to reduce risks in the transaction process and after the takeover. Clear communication of the findings supports the negotiation strategy and increases transaction security. Example: A global technology company planned to acquire a start-up that offers AI solutions. The due diligence revealed above-average development costs, legal disputes and pronounced sales risks from a small number of major customers. The information was used to negotiate the purchase price and integrate protective mechanisms, namely an earn-out clause, into the transaction agreement. The clearly communicated due diligence findings effectively supported the negotiations and were a success factor in concluding the transaction.
Conclusion A value-creating FDD makes it possible to take well-founded decisions in the transaction process, to seize the opportunities of an acquisition and to reflect the risks in the purchase price and the contracts. With our integrated approach of targeted Financial Due Diligence, Valuation and M&A Advisory, we support clients from a single source to create a solid decision-making basis for the review of transactions and ensure the success of acquisitions.
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