Guide to Financial Due Diligence

For Mergers,
Mergers Acquisitions,
Acquisitions Private Equity & Venture Capital

KANG, Jong Tak

PARK, Jae Hong

Financial Advisory Services

October 6, 2005
 1. Due Diligence Process Overview

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 Financial and Tax Due Diligence Process

Due Diligence Activities

Supplemental Closing /
Target’s Management Financial Definitive Bring Down
Background Data Room Interviews / Data Model Agreements
g
auditor Diligence
Requests/Analyses

Communication, Analyses, Interim Deliverables

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 Due Diligence Process
Improve/Validate
Valuation Model
&DDeall St
Structure
t
Financial

Tax
Maximize
Value Operations Synergy
Drivers
Technical
Develop
Value drivers Diligence IT Additional
determine the Negotiating
merit, price, and P
Procedure
d Human Capital Leverage
structure of a
transaction – and
define the nature Risk Management
Provide feedback
and scope of the on Acquisition
due diligence Forensic / Agreements
Investigative
Services

Legal Identify, Assess &

Minimize Risk

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 2. Pre Due Diligence – Getting started

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 Launching a Project

• New client acceptance / background checks

• Pre approval by audit committee, if applicable
• Engagement letter
• SA setup
• Infrastructure for foreign office billing
• Budget
g
• Working group list
• Look up other office team members on warehouse
• Travel plans, directions
• Confidentially agreement

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 Launching a Project - What Should I Ask ?

• Who is our client?

• Is this an existing client?

• Who do we need on this deal from our group?

• What other functions should be involved?

• Foreign office involvement?

• Are we going to need industry specialists?

• Who does the tax compliance / advisory work?

• When will we have access to the auditors?

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 Launching a Project - What Should I Ask (cont’d)?

• What are the deadlines?

• What is the fee expectation?

• What are foreign office’s fee expectations,

expectations exchange rate?

• What kind of report does the client expect and how often?

• Will this be a phased approach?

• What do we need to bring to the company / data room?

• Dress code?

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 Launching a Project - What Else Should I Be Doing ?

• Set up initial call with client and target

• Understand client’s expectations re: scope and deliverables

• Lookup background information

• Comparative regulatory body (i.e. SEC, FSS, etc) filings

• Distribute information package

• Develop work plan, issues list

• Document request list

ƒ Consider
C id existing
i ti d
data
t room iindex
d iinformation
f ti
• Access letter (Accounting and Tax)

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 Launching a Project – Key Information
• Initial information package
• Client
Cli t contact
t t information
i f ti
• Target contact information
• Client and Target advisor information – attorneys, actuaries, etc.
• Target offering memorandum (“OM”) / Information Memorandum (“IM”)
• Letter of intent (“LOI”) / Memorandum of Understanding (“MOU”)
• Term sheet
• Client model – capital structure and method of financing
• Draft purchase agreement
• Client memoranda / acquisition analyses
• Competitor filings
• Data room index
g Company
• Target p y Website

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 Launching a Project – Data Request Considerations

• Auction, exclusive, public, etc.

• Agreed upon scope and work plan

• Prioritize requests

• Existing info – i.e. data room documents

• Time period requested

• Requests should be numbered to organize responses

• Use to facilitate discussions with management

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 Launching a Project – Client’s Viewpoint
• Primary motivation / Value Drivers
• Pricing
P i i
• Risks / Exposures
• Opportunities
• Hold / Exit strategies
• What is the quality/reliability/sustainability of EBITDA/GAAP earnings?
• Are “normalizing” adjustments appropriate?
• What is stability/certainty/reliability of future cash flows?
• Walk away from deal?
• Reduce/modify offering price?
• Obtain contractual protections?
• Change post-acquisition plans?
p y and where are “black holes”?
• Where is the value of the company
• Management capabilities?

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 Launching a Project – Client’s Need

• How is our client going to utilize our work product?

• Structure and value deal

• Negotiate purchase price and purchase agreement

• Negotiate covenants

• Determine future financing strategies

• Identify post closing operational focus areas

• Financial statement impact of transaction

• Apply impact of accounting principles

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 Launching a Project – Deal Considerations

• Strategic vs. PEI (Private Equity Investor)

• Auction vs. exclusive

• Geographical / channel / market share expansion

• Asset vs. stock deal

• Cash flows / EBITDA

• GAAP earnings

• Exit strategy

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 Pre Due Diligence – Prepare Preliminary Issues List

• Dependent on available information (10K, OM, etc)

• Highlight preliminary issues to focus diligence efforts

• Consider timing and prior experience with client

• Refine scope

• Look for deal breakers

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 Pre Due Diligence – Balance Sheet and Income Statement

Objective – identify:
ƒ Major fluctuations
ƒ Non-recurring
g items
ƒ Significant accounts
ƒ EBITDA adjustments
ƒ Normal levels / seasonal trends
ƒ Working capital requirements
ƒ Unusual accounting practices
ƒ Impact of changes in accounting practices
ƒ Tax exposures
ƒ Unrecorded obligations / liabilities

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 Pre Due Diligence – Financial Model

• Transaction structure and accounting & tax treatment

• Consistency with pre due diligence

• Return sensitivity to financial factors

• Integrity of model

• Tax considerations

• Sources & uses of funds

• Future operating plan i.e. spin-off, add-on

• Timing

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 Pre Due Diligence – Transaction Agreements (LOI, term
sheet, MOU, financing agreements)

• Structure proposed

• Purchase price adjustment mechanism

• Representation and warranties

• Earn outs

• Debt covenants

• Tax indemnities and basis for tax allocations

• Timing

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