The need for Due Diligence in Mergers and Acquisition
Alamin Ahmednegash sied
COVID-19 has affected most SME business sectors in 2020 and the current year 2021. The impact of the pandemic still exists in current market which is forcing many businesses to close their businesses and face financial losses.
With the start of COVID -19 vaccination and re-opening of markets, many companies which were having good market position pre-covid are planning to continue their activities either by merging with other business entities in the same sector or selling out their business.
At this point, due diligence is required, which is the process of investigation or verification that takes place before entering into an agreement with a target entity to determine the risk and unexpected/unforeseen liabilities which may arise in the future.
The buyer/investor, before taking over or merging with other entity, needs an assurance of what they are getting and would need to know several important details. Some of them would include:
- Fair valuation of the entity, what he is buying, nature of the business, and sustainability
- Asset condition- wear and tear, useful life
- Aging of receivables and inventory
- Intellectual property and resources that the entity has ( man-power skill and other resources)
- Any onerous or binding contracts
- Liabilities and guarantees made by the entity or group companies
- On-going litigation and any government proceedings against the entity
- Relationships with existing customers, major customer dependencies
- Lead pipelines and prospects of potential customers
- Unusual income or expenses which result in a misrepresented financial report – window dressing, inter-company activities, etc.
- Dependence on key employees and the likelihood of their tenure
- Other financial and operational details
The due diligence will help the investor to decide whether the deal is valuable while comparing to their portfolio or not. Due Diligence also provides financial forecasts and key assumptions to the buyer to assess the feasibility of the forecast.
A good Due Diligence will cover wider details that include financial, operational, and technical information – going far beyond financial statements or a statutory audit report.
Such a Due Diligence will cover the below areas:
- Review of historical (say, last three to five years) financials and the current period’s trial balance to give detailed financial ratio analysis and hence, projections of the target future performance.
- Analyze Product/service/branch wise revenue and profitability and recommendations on key operational decisions such as produce v/s buy and close v/s open markets (or outlets in the case of retail) etc.
- Details of contracts with customers who have contributed to a large portion of revenue.
- Give details for pricing mechanism and considerations (including discounts, promotions, etc.) and historical evolution of pricing for all revenue streams.
- Details of other income, including any financial income, grants, the release of provisions, etc., recorded during the period under review.
Liabilities and other areas
- Employee End of service calculations and detailed provision workings
- Details of any other liabilities with respect to other stakeholders (staff – excluding EOSB, vendors, Federal Tax Authority, shareholders, etc.)
- Details of any identified off-balance-sheet contingencies and/ or commitments, including any lease obligations
- Details of any debt from third parties, including related parties with background, and progressive repayment details
- Documents pertaining to all pending Leases, Guarantees, Major payable commitments
- Details of pending litigations if any, including litigations pertaining to frauds, IT security breaches, thefts, etc.
- Review the legal documents Trade licenses, Memorandum of Association(M.O.A.)
- Review the details of legal due (Tax and other due)
HLB HAMT has a team of Due Diligence experts in UAE who can assist in recognizing possible risks and potential opportunities and make the process of mergers and acquisitions easier to handle, thorough and diligent.
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