Jimmy Rodefer: In M&A due diligence, let buyer beware

If you're thinking of acquiring a company, it's good to remember that old sayings become old sayings because there's truth in them, as in, "Let the buyer beware."

Here's a situation in which the buyer apparently wasn't wary enough, from an Aug. 15 article on the digital news outlet Quartz:

Chinese e-commerce giant Alibaba said today that it has found accounting problems at its newly acquired television and film production company, now known as Alibaba Pictures ...

One might think that in a highly scrutinized, multi-billion dollar acquisition, the best accounting minds would analyze every aspect of the deal so that no one is being made an offer he or she should refuse.

But it happens.

From the Feb. 3, 2014, Wall Street Journal:

Hewlett-Packard Co. said it found major accounting errors in an audit of the 2010 financial statements of U.K. software maker Autonomy, the first significant evidence backing up H-P's claim that Autonomy inflated its revenue and profit before the U.S. company acquired it.

Whether the companies involved are small or large, in the excitement of buying a new company — like buying a new car — it's possible critical factors are overlooked in the desire to drive that baby off the lot.

Smaller companies making an acquisition may not bring to the process accountants and financial professionals experienced in business valuation and who have the ability to dig deeply into the target company's financial statements and information.

Here are suggestions on steps after both companies have agreed on a letter of intent:

• Set a specified period of time to conduct due diligence, but don't rush and overlook important data. A good benchmark is 60-90 days.

• Avoid cutting corners. If you need — or think you need — outside advice, counsel, or experience, bring it into your process.

• Compute your own key performance indicators, and ask the seller to provide what it thinks are its key performance indicators.

• Be sure to understand customer retention and loss ratios; review insurance policies to see if the underwriters assigned high risk to any company activities.

• Make sure that all benefit plans are not underfunded and comply with rules and regulations.

• If the company has its audited financials for review, understand that certain details important to you may have not been verified within the audit's scope.

• If the target company lacks audited financial statements, it's not world-ending, but at a minimum expand your due diligence procedures to ensure you're comfortable with financial information accuracy.

• Look carefully at the target company's legal and financial advisers. Have they been in trouble? If so, the target company might be sitting on unknown or unseen problems.

• Talk to vendors, customers, and others who have had a relationship with the company and find out what do they know that you need to know.

• All parties should agree on, and sign, a confidentiality agreement.

• Most importantly, put the right people on your team.

It vastly improves your chances of emerging from an M&A with your reputation intact, your finances protected, and your future brighter. Otherwise, you may end up wishing you'd paid more attention to good old sayings.

This article appeared in the Sunday, September 28, 2014 edition of the Knoxville News Sentinel.