How to help ensure that your deal doesn’t fail

Reflecting on the projects undertaken over the last 12 months by our transaction services team, what are the common due diligence (DD) pitfalls? Where have sellers lost value through the due diligence process? And, in extreme circumstances, what has caused transactions to fall over?

Of the 61 projects that our due diligence team worked on over the last year, almost a quarter uncovered issues of large enough significance that it resulted in either:

• Reductions in price
• Deal postponements
• A restructure of the deal in favour of an earn-out
• Caused the acquirer or funder to decide not to progress further with the transaction

This blog highlights the key themes.

Weaker trading against budget and forecasts

Given the economic uncertainty over the last 12 months, it is not surprising that business trading performances varied during the period of a transaction. Some transactions were postponed because of poorer-than-expected trading. Whereas others were re-structured in favour of an earn-out structure.

Although it is not an easy task, business owners must focus on their core business and trading, even while trying to execute a transaction.

We also find that those businesses with better quality of financial and trading information are more effective in explaining any temporary trading issues and may be able to put an investor’s mind at ease.

Issues with quality of financial information and records

In a number of cases, financial information has not stood up to scrutiny. This results in significant adjustments, which have negatively impacted the reported trading performance. Where an offer is based on a level of profitability, which is subsequently revised, this leads to a substantial risk of revision to the deal structure.

We also find, particularly in private equity backed deals, that a lack of quality or depth in data to support the value story can pose a significant issue. This could be looking at profitability by customer or contract. Investors want to be able to see data that supports the value proposition in which they are investing.

We are increasingly seeing that high-quality data is invaluable in a transactional setting. Read our recent article on driving value in your business with data insights for further understanding.

Lack of suitable tax control environment or a high-risk approach to tax compliance

A common DD issue that we come across is a ‘laissez-faire’ attitude to tax compliance. The most common example being the treatment of shareholders’ personal expenses and the treatment of company vehicles. Both have impacts across multiple taxes.

We have also come across several high-risk or poorly advised tax planning arrangements, or other tax planning ideas that were incorrectly implemented.

As well as the potentially significant financial implications, this also paints a poor picture in the eyes of an investor on risk profile of their potential investment.

The short-term tax benefits of adopting aggressive tax treatments are far outweighed by the risks at the point of a transaction. In our recent experience, these include:

• Price chips
• Tax-related holdbacks
• Investors walking away from the transaction entirely

Historic share transaction errors

A recurring problem area is poorly documented, or even wholly undocumented, share transactions. For example, share buy-backs and transfers; change of share rights; or the issuing of new shares.

It is possible to rectify these issues. But it becomes much harder once a transaction has commenced. It can involve significant tax risks both historically and in taking rectification steps.

What makes a smooth due diligence process?

Reflecting on the smooth-running transactions, they broadly set out the same terms. But what common themes do these businesses share?

• High-quality financial and operating data

High-quality financial information is the backbone of a successful transaction. It ensures there are no surprises uncovered at the point of due diligence.

• Quality advisors

We find that where high-quality advisors are engaged – both as part of the transaction and for ongoing accounts and tax services – transactions tend to run much more smoothly. Good-quality advisors tend to pay for themselves in the long-term. This is especially true at the point of a transaction.

• In-depth commercial understanding

Transaction outcomes improve when sellers have a deep understanding of their business and can articulate the key value drivers and reasons behind historical trends. This is further improved with operational data that supports the narrative explanations.

• A good-quality financial model, rooted in historical data

It is tempting to want to show dramatic sales growth and exponential increases in profitability. But that credibility of financial modelling, with thought-out assumptions grounded in historical precedent, are far more effective at standing up to due diligence and gaining the confidence of an investor.

• Clean tax affairs

Clean tax affairs avoids any awkward conversations around historic tax liabilities. It also helps to paint the business in the best possible light.

• Be prepared

Prepared businesses spend less time and resources scrambling to be ready for due diligence. They can spend more time focusing on maintaining strong trading results and give themselves the best chance of an efficient process while also protecting value.

How can PKF Francis Clark help you?

You need comprehensive support when you approach a transaction. As financial due diligence experts, we will provide you with the support and confidence that your business will stand up to scrutiny during the due diligence process.

Our team of transaction tax specialists will advise you if there are any concerns around historical tax compliance, or if you are unsure about the execution of any historic share transactions.

Additionally, our data analytics and cyber teams will help you get the most out of your data and ensure your cyber estate is in the best possible health ahead of a transaction.

Contact our due diligence experts today.