M&A due diligence: don’t accept financial statements at face value

The M&A market was hot last year, and that momentum is expected to continue in 2019. Before acquiring another business, however, it’s important to do your homework. Conducting comprehensive due diligence can be a daunting task, especially if you’ve never negotiated a deal before. So, consider seeking input from an experienced accounting professional.


Reviewing historical performance

For starters, the target company’s historical financial statements must be reviewed. This will help you understand the nature of the company’s operations and the types of assets it owns — and the liabilities it owes.


When reviewing historical results, it’s important to evaluate a full business cycle, including any cyclical peaks and troughs. If a seller provides statements during only peak years, there’s a risk that you could overpay.


Historical financial statements also may be used to determine how much to offer the seller. An offer should be based on how much return the business interest is expected to generate. An accounting expert can project expected returns, as well as provide pricing multiples based on real-world comparable transactions.


Evaluating the target’s historical balance sheet also may help you decide whether to structure the deal as a stock purchase (where all assets and liabilities transfer from the seller to the buyer) or as an asset purchase (where the buyer cherry-picks specific assets and liabilities).


Looking to the future

Prospective financial statements are typically based on management’s expectations for the future. When reviewing these reports, the underlying assumptions must be critically evaluated, especially for start-ups and other businesses where prospective financials serve as the primary basis for your offer price.