FINANCIAL DUE DILIGENCE for a Business Acquisition

Contact Neufeld Legal PC for corporate transactional and legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

Financial due diligence is a detailed examination of a target company's financial records to verify the accuracy of the information provided by the seller. The goal is to identify potential risks, uncover liabilities, and confirm the business's financial health, performance, and value before the transaction closes. It's a critical step that goes beyond a simple review of financial statements to provide a true picture of the company's economic reality, which is used in conjunction with the other areas of due diligence, including legal due diligence, to assess the viability of the target business and those concerns that need to be addressed prior to completing the proposed transaction.

Key areas of financial due diligence include, but are not limited to:

• Quality of Earnings (QoE): This is often the most important part of financial due diligence. QoE analysis goes beyond the reported net income to determine if a company's earnings are sustainable and repeatable. Analysts will look for one-time or non-recurring expenses and revenue, such as a major equipment sale or a legal settlement, and adjust the earnings to reflect the true, ongoing profitability of the business. The result is an adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) that is a more reliable indicator of the company's financial performance.

• Working Capital Analysis: This step evaluates the target company's working capital, which includes its current assets (like accounts receivable and inventory) and current liabilities (like accounts payable). The goal is to ensure the business has enough liquid assets to cover its short-term obligations and to determine the level of working capital needed to run the business smoothly post-acquisition. Analysts also look for any unusual trends or accounting practices that might inflate working capital figures.

• Debt and Capital Structure: You must confirm all existing debt and liabilities. This includes reviewing loan agreements, lines of credit, and any off-balance-sheet items. It's crucial to understand the terms of any outstanding debt, including interest rates and repayment schedules. This analysis helps you determine how debt will be handled as part of the transaction and what your financial obligations will be as the new owner.

• Tax Due Diligence: This focuses on a thorough review of the company's tax returns and tax compliance history. The purpose is to identify any potential tax liabilities or outstanding tax issues that could result in penalties or unexpected costs for the buyer after the acquisition.

Financial due diligence is essential for three main reasons:

• Risk Mitigation: It uncovers "red flags" and hidden liabilities, such as undisclosed debts, pending lawsuits, or tax non-compliance. Identifying these risks allows you to either walk away from a bad deal or negotiate a lower purchase price and include protective clauses in the purchase agreement.

• Valuation Verification: It validates the business's valuation. The asking price is often based on the seller's reported financials, but due diligence confirms if those numbers are accurate. You can adjust your offer based on a more realistic view of the business's financial health.

• Informed Decision-Making: Ultimately, financial due diligence provides the buyer with the complete and accurate financial information needed to make a sound business decision. It replaces assumptions with facts and helps you understand the true nature of the business you are about to acquire.

When it comes to the legal component of corporate mergers & acquisitions, beginning with legal due diligence, that is when the law firm of Neufeld Legal P.C. comes into play. Such that when you are seeking knowledgeable and experienced legal representation in orchestrating and completing business mergers, acquisitions and divestitures, contact us at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.