Deal or No Deal? M&A Due Diligence Could Make All the Difference

by Deborah A. Nappi, CPA, MST, Sax LLP – October 12, 2018
Deal or No Deal? M&A Due Diligence Could Make All the Difference

In recent years, mergers and acquisitions (M&As) have continued to be prevalent in New Jersey as business owners look to monetize their companies, and private equity has been an option in lieu of succession planning. New Jersey’s M&A activity in the first quarter of 2018 showed a slight decrease, however the value of the transactions has increased.

Clients may be enticed by the antici­pated multiples and the volume of recent transactions, but they must consider whether their organization is ready to undertake the in-depth due diligence process that will bring the transaction to closing. Due diligence is the most critical compo­nent to a successful M&A transaction, and CPAs can provide tremendous value by providing a roadmap for this process.

Why Do Due Diligence?

The purpose of the due diligence process is to evaluate all aspects of the business prior to the acquisition. Financial records are re­viewed in great length providing the business purchaser with a level of comfort as to the financial viability of the entity and the predictive future of the organization’s EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and cash flow.

There are various important aspects of the due diligence process, including legal, operational, intellectual property, commercial, information technology and human resources.

Clients need to be appropriately counseled prior to contemplating a sale to identify any issues which might impede or devalue the sale of their business. A purchaser is going to look back several years to identify key trends and performance indicators. Incomplete data and poor-quality data can lead to a breakdown in the due diligence process. The seller needs to provide consistent monthly financial data with detailed reconciliations for significant accounts such as accounts receivable, inventory, accounts payable, ac­crued expenses payroll and other significant account balances. Explanations need to be provided for all discrepancies noted.

As a client’s trusted advisor, how can a CPA assist them to be better prepared for this intricate process? If the plan is to sell to private equity, processes should be put in place long before a transaction is considered to ensure that the financial information will be accessible and that the records provided are complete and accurate. Much consideration should also be given to accounts with lingering differences in need of adjustment.

These proactive measures will require the client to assess the various processes within their organization, and this assessment will undoubtedly uncover weaknesses which can be remedied prior to the sale. The CPA’s ex­pertise and assistance here will be essential. Accounts worthy of consideration for review are: accounts receivable; inventory; fixed assets; accounts payable; accrued expenses; revenue and various expense categories; and leasing arrangements.

Tips for a Successful Due Diligence Process

  • Review the accounts receivable aging with the client to gain a better under­standing of their collection process and the cause of growing receivables.
  • Inquire regarding credit limitation for new customers and sales cut-offs. It is an opportunity to reveal any underlying processes which need correction.
  • Review the accounts payable aging schedule. Are there proper monthly cut-offs and are the months’ invoices recorded? Are vendors’ statements compared to the aging schedule and are noted discrepancies followed up with the vendor?
  • Review all leasing arrangements in detail.
  • Review inventory values and respective reporting.
  • Review fixed asset schedules to ensure accuracy and completeness of fixed assets presented on the detailed schedule.
  • Prepare detailed analysis of prepaid accounts and accrued expense accounts on a monthly basis.
  • Prepare analysis and substantiation of high-volume expense accounts.

Tax planning is another element of the transaction that must be weighed heavily. Consideration must be given not only to the corporate taxes but also to the buyers’ and sellers’ personal and estate tax planning.

This might sound simplistic, but for com­panies that do not have controllers overseeing their accounting process, inconsistencies will become visible when reviewing com­parative monthly financial information. In addition, it is important to understand the compliance issues of the industry that the client specializes in. Healthcare, for example, is fraught with many regulatory compliance matters. A client’s financial presentation might be stellar, but the assessment may uncover some internal practices that are not compliant with industry standards.

Monetizing a business can be successful for many clients, but taking advantage of an M&A opportunity requires a great deal of detail and strategy to ensure it is a success. Providing a roadmap for a well-executed due diligence process will be rewarded in the long run and ensure the outcome aligns with the intended goals.


Deborah A. Nappi

Deborah A. Nappi

Deborah A. Nappi, CPA, MST, is a director at Sax LLP and a member of the firm's healthcare practice. She is a member of the NJCPA Federal Taxation Interest Group and can be reached at dnappi@saxllp.com.

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This article appeared in the September/October 2018 issue of New Jersey CPA magazine. Read the full issue.