Muscling Through Acquisition Financing Due Diligence

Posted on: December 31st, 2021

acquisition financing

A buyer who wins a deal usually feels excitement, only for this elation to give way to more somber thoughts of due diligence. Due diligence is the great equalizer in acquisition financing and determines whether the deal is finance worthy. Often a buyer, goes light on the seller in the pre-sign-up stage, creating a false sense of non-intrusiveness. When the real diligence starts, sellers can often be in for an abrupt surprise.

Acquisition financing due diligence occurs across two important fronts – business and financial. Both areas require a comprehensive analysis by a team of expert diligence specialists. Experienced buyers put together teams that can muscle through this process, based on efficient work flows and talented personnel. The diligence teams must have skill at asking the right questions and putting the answers into the right context. There are obvious things to corroborate or refute such as EBITDA adjustments and revenue recognition to name a few. The more subtle and less noticeable findings have to do with unusual patterns of profitability, cash distributions and internal control weaknesses. There are several key practices to muscling through the acquisition financing diligence process:

Business diligence before the financial diligence – When a buyer knows a lot about a company and its financial reporting, they can help the financial diligence team set the scope and jumpstart their review. Sensitive areas will receive more scrutiny, which will help build comfort for the buyer.
Operational Perspective – all buyers need to bring a ground floor level perspective to the business diligence. Focus should be on understanding the people, processes, systems, and customers from a bottoms-up standpoint.
Unusual Balance Sheet Item Review – many small companies have candy store accounting, which does not reflect proper accrual balance sheet accounting, let alone GAAP. Often unusual balances build up, that are not properly relieved to the P&L, that can have a material impact on current profitability.
Strong Quality of Earnings Team – the financial review is only as a strong as the quality of the people performing the work. Make sure the team has a good track record and direct experience with buy-side acquisition financing diligence.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.