Due diligence is a critical element in the analysis of any corporate acquisition, and your firm's Financial Planning and Analysis (FP&A) Department should play a pivotal role in the process. Having been involved in a number of due diligence exercises over the years, here are my thoughts on what a good process should look like.
The purpose of due diligence
The primary purpose is to affirm or correct your company's estimate of the financial value of the target. Before proceeding with acquisition discussions, FP&A already should have performed a discounted cash flow analysis of the target, accounting for the value of the target's future business prospects and liabilities. Many assumptions factor into such an evaluation; due diligence can confirm or modify these assumptions, while identifying additional factors which could change the valuation.
Due diligence also identifies issues that will need to be addressed during the integration phase of the acquisition. However, due diligence is not part of the integration process. Therefore, you need to be selective about what data you seek and analyze. Only information having a material impact on the valuation is of interest.
Who is involved?
The larger the acquisition, the more colleagues you will need on the due diligence team. Typically, you will need representatives from Legal, Accounting, Operations, Human Resources, Treasury, FP&A, Sales/Marketing, Tax, Risk Management/Insurance, Information Systems, and Environmental (if relevant).
There should be a single point of contact for the due diligence team, both internally and externally. This individual is responsible for coordinating the activities of the team, arranging data room visits, making information requests to the acquisition target, and receiving and distributing information. The point person also should arrange regular and frequent meetings or conference calls of the due diligence team to share information and identify further areas for research.
What information is needed?
Even for a modest acquisition, the list of information needed is somewhat daunting. For example, when Land O'Lakes acquired Purina Mills Inc., the initial due diligence request was 31 pages long, and the entire process took about six weeks to complete.
An entire due diligence request list is too long to be printed here, but it should include key questions from each of the departmental participants on the due diligence team. Items should be screened to eliminate "nice-to-know" items and integration issues, in favor of "need-to-know" items affecting the valuation of the target. Some examples include:
- Corporate structure and organization charts
- PP&E detail
- Employee benefits
- Sales detail and projections;
- Operating costs and corporate overhead
- Capital expenditures
- Bank accounts and cash balances
- Debt and other liabilities, including contingent liabilities
- Information systems and associated costs
- Opportunities for synergies/cost savings
- Working capital requirements and seasonality
- Risk management
- Environmental liabilities, and
- Pending or threatened litigation.
5 critical success factors
A few more thoughts on critical factors that will lead to a successful due diligence experience:
- Appoint a central point of contact. I mentioned this above, but it cannot be overemphasized. There should be one individual named at the acquiring company and one at the target company who will be responsible for tracking the information requests and confirming that acceptable responses have been provided.
- Set clear objectives. Each due diligence team participant should be familiar with the basic assumptions of the financial analysis, and be on the lookout for any data which confirms or changes those assumptions. (Note that team members will not necessarily know the results of the analysis because they typically are confidential.). Information requests need to stay focused on the highest value/cost items.
- Communicate frequently. Written reports should be requested of each team participant, summarizing only those items which could have an impact on the valuation. Weekly conference calls of the team are recommended.
- Maintain confidentiality. Most acquisitions are highly confidential and need to be kept that way. Only those with a "need to know" should be involved. Also, information obtained from the target may only be used for purposes of the acquisition decision, and often must be returned in the event that the acquisition fails to materialize.
- Use the data. This is not an exercise to see who can build the biggest file. As data is collected, it needs to be sifted by FP&A to see how it affects the valuation model and sensitivities. The resulting changes in the valuation need to be promptly reported to management and the negotiating team.
Pete Simonse, CTP, is Vice President & Treasurer, Land O'Lakes Inc.