The benefits of doing financial and legal due diligence

If you are considering a merger or acquisition, it’s essential that you take professional advice before taking any decisive steps. One of the most important parts of the process is due diligence – a legal and financial assessment of any potential risks in the transaction. 

This requires an investigation of the obligations and liabilities of the other company and is generally carried out by accountants and solicitors.

Financial due diligence

A financial due diligence review assesses the historical financial performance of the other company and its forecast financial performance. The aim of the review is to consider if the forecasts are reasonable and represent a true and fair view of the other company’s performance.

The findings of the review provide information that is essential to finding a fair purchase price that is agreeable to both parties. 

The review should also investigate the reasons behind any significant trends or changes in historical results. To carry out financial due diligence, accountants review three types of information: 

• Historical records such as statutory financial statements and management accounts
• Current financial data such as management accounts for the year to date
• Financial forecasts such as budgets and cash flow forecasts.

During the assessment, accountants consider if the information is reliable and if historical earnings are sustainable. Looking at current performance and future forecasts they try to establish potential future earnings and consider any tax consequences based on the forecast. 

They use their professional judgement to assess if any warranties and guarantees should be included and if there are any factors that could be considered potential deal breakers. For example, there may be large tax liabilities, outstanding debts or impending financial penalties. 

Although they may not break the deal, these factors would be the subject of further negotiations over the purchase price. 

Legal due diligence

Legal due diligence can help you find out more about a number of aspects of the other company, including: 

• The corporate structure
• Its commercial contracts and whether they can be transferred to a new company
• Employment policies
• Intellectual property
• Environmental and health and safety record and policies 
• Regulatory compliance requirements 
• Outstanding litigation issues 
• Property ownership and other assets.

Like financial due diligence, this legal assessment can help you decide if the purchase price is fair and if there are any significant risks that should be covered by guarantees. 

If you would like more information about buying or selling a business, please call George Skelton at 053 9170507