Planning an Exit or Capital Raise?

By in Accounting and Finance, Technology

Will your business data and documentation stand-up to a robust Due Diligence process in the event of an Exit or Capital Raise?

If you are planning a sale of business or equity capital raising in the short to medium term, it is critical to the success of that process that your business data and documentation is in shape and will withstand the rigours of a due diligence process.

In today’s M&A environment, acquisitive companies and investors such as listed companies, family offices, Private Equity funds and Venture Capital funds are highly sophisticated when it comes to assessing the merits of their proposed investment. These parties will carry out extensive due diligence processes that are likely to involve:

  • Engaging specialist accounting firms to conduct financial due diligence and taxation due diligence;
  • Engaging specialist law firms to conduct legal due diligence; and
  • Extensive due diligence being conducted by the acquirer / investor either itself or through external specialists (or a combination of the two) in relation to many other facets of a business including commercial and operational matters, information technology and security, treasury, environmental matters, human resources etc.

Below are our top 6 recommendations for preparing your business data and documentation to withstand a robust due diligence process:

1. Recognise revenue and profits in accordance with the applicable accounting standards:

  • Your business may not be required to prepare general purpose financial statements and therefore, be compliant with Australian or International Accounting Standards. However, acquirers who are required to comply with such accounting standards will likely want to understand what the target’s revenue and earnings look like when accounted for in accordance with these standards, as this is key for assessing the impact of the acquisition on the acquirers consolidated earnings.
  • We have seen many instances where businesses are not recognising revenue on a proper accruals basis and in accordance with the accounting standards. The result is the potential acquirer requesting significant reconciliations from the target to convert historical revenues to an accrual basis. This is a costly exercise and can materially delay the sale / capital raise process.
  • Undertaking an assessment of how to recognise revenue correctly and transitioning to the revised recognition methodology, may allow your business to compile multiple years’ worth of comparable historical data with the correct treatment. This can be provided to the potential acquirer / investor in a due diligence process.
  • Similarly, costs such as employee entitlement provisions and lease expenses should be accounted for in accordance with the accounting standards.

2. Have your financial statements audited:

  • Having your businesses financial statements audited by a reputable firm often provides the potential acquirer / investor with greater confidence regarding the accuracy and reliability of the data they are analysing in the due diligence process.
  • Having audited financial statements also reduces the risk that the potential acquirer / investor identifies issues that give them scope to ‘chip away’ at the purchase price.
  • With most sale transactions structured as a multiple of revenue or earnings, changes to the top or bottom line might not seem all that significant. However, they can have a material impact on the consideration or proceeds received when capitalised by the applicable multiple.

3. Review your important business contracts:

  • Sophisticated investors will conduct extensive legal and commercial due diligence on critical business contracts. This includes customer agreements, key supplier agreements, lease and licence agreements etc.
  • Review these important contracts now, to ensure that they are all in order and up-to-date e.g. signed by all parties, are current, don’t include any onerous change of control clauses etc.

4. Assess whether you are capturing revenue and gross margin data by all relevant metrics for your business:

  • A key part of a financial due diligence process is assessing the Quality of Earnings (“QoE”) of the target. A QoE analysis includes testing revenue and gross margin by all relevant metrics e.g. by customer, by product / service, by region, by salesperson, by recurring revenue %, by attrition / renewal rates etc.
  • Ensuring that your business is capturing revenue and gross margin data by all relevant metrics for your industry, is key to allowing potential acquirers / investors to get comfortable with the quality and sustainability of the earnings of your business. For example, for software businesses, capturing the % of revenue that is recurring in nature is a key metric.
  • Where possible, you should also attempt to compare relevant revenue, gross margin and operating expense metrics against industry benchmarks now, to assess your position relative to the market.

5. Prepare a well-structured financial forecast model and monitor the business against budget:

  • Preparation and maintenance of a robust financial forecast model, together with regular monitoring of actual performance vs. budget, allows you to evidence that the business has been well managed.
  • The ability to provide historical budgets from that financial model may also give the potential acquirer / investor confidence regarding the businesses ability to reliably forecast performance.  This would increase the likelihood of achieving a transaction multiple based on forecast revenue or earnings.
  • A sound financial model may also assist the purchaser in funding the deal.

6. Ensure your tax lodgements are up-to-date and consider engaging tax specialists to conduct tax vendor due diligence:

  • Engaging reputable tax specialists to conduct vendor due diligence may provide you with confidence about the tax lodgements and history of your business. This will put you in a stronger position when it comes time to negotiate the various tax clauses, warranties and indemnities to include in a sale or share subscription agreement. Vendor due diligence can also be provided to potential acquirers / investors to accelerate the process, reducing your overall advisory costs.
  • Tax specialists will review your corporate group to see if you can access the various tax concessions and rollovers available, helping you structure the sale in the most tax-effective manner.

William Buck are specialists in preparing businesses for sale or investment and can assist with the above items to ensure your data and documentation withstands an extensive due diligence process.

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